================================================================================
                     SECURITIES AND EXCHANGE COMMISSION
                           Washington, D.C. 20549

                                  FORM 10-K

              ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                     THE SECURITIES EXCHANGE ACT OF 1934
                 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
                       COMMISSION FILE NUMBER 0-11595

                         MERCHANTS BANCSHARES, INC.
           (Exact name of registrant as specified in its charter)

      Incorporated in the                  Employer Identification
       State of Delaware                       No.   03-0287342

  164 College St., Burlington, Vermont               05401
(Address of principal executive office)           (Zip Code)

                Registrant's telephone number: (802) 658-3400
         Securities registered pursuant to Section 12(b) of the Act:
                              (Not Applicable)
         Securities registered pursuant to Section 12(g) of the Act:

            Title of Class: Common Stock (Par Value $.01 a share)
                  Name of Exchange on which listed:  NASDAQ

Indicate by check mark whether the registrant (1) has filed all reports 
required to be filed by Section 13 or 15(d) of the Securities Exchange Act 
of 1934 during the preceding 12 months (or for such shorter period that the 
registrant was required to file such reports), and (2) has been subject to 
such filing requirements for the past 90 days.

                          Yes   X           No
                              -----            -----

Indicate by check mark if disclosure of delinquent filers pursuant to Item 
405 of Regulation S-K is not contained herein, and will not be contained, to 
the best of registrant's knowledge, in definitive proxy or information 
statements incorporated by reference in Part III of this Form 10-K or any 
amendment to this Form 10-K.

               X   Contained herein        Not contained herein
             -----                   -----

The aggregate market value of the voting stock held by non-affiliates is 
$101,568,581 as computed using the average bid and asked prices of stock, as 
of March 6, 1998.

        The number of shares outstanding for each of the registrant's
              classes of common stock, as of March 6, 1998 is:
               Class:  Common stock, par value $.01 per share
                        Outstanding: 4,430,294 shares

                     DOCUMENTS INCORPORATED BY REFERENCE

      Portions of the Annual Report to Shareholders for the year ended 
December 31, 1997 are incorporated herein by reference to Parts I and II.

      Portions of the Proxy Statement to Shareholders for the year ended 
December 31, 1997 are incorporated herein by reference to Part III.
================================================================================

TABLE OF CONTENTS                                                    Page


Independent Auditors' Report                                           3


Consolidated Balance Sheets                                            4


Consolidated Statements of Operations                                  5


Consolidated Statements of Changes in Stockholders' Equity             6


Consolidated Statements of Cash Flows                                  7


Notes to Consolidated Financial Statements                             8


Summary of Unaudited Quarterly Financial Information                  29


Five Year Selected Financial Data                                     32


Management's Discussion and Analysis of Financial Condition
 and Results of Operations                                            33


Form 10-K                                                             43


Signatures                                                            65


TO THE STOCKHOLDERS AND BOARD OF DIRECTORS OF
MERCHANTS BANCSHARES, INC.


We have audited the accompanying consolidated balance sheets of Merchants 
Bancshares, Inc. (a Delaware corporation) and subsidiaries as of December 
31, 1997 and 1996, and the related consolidated statements of operations, 
changes in stockholders' equity and cash flows for each of the three years 
in the period ended December 31, 1997.  These consolidated financial 
statements are the responsibility of the Company's management.  Our 
responsibility is to express an opinion on these consolidated financial 
statements based on our audits.

We conducted our audits in accordance with generally accepted auditing 
standards.  Those standards require that we plan and perform the audit to 
obtain reasonable assurance about whether the financial statements are free 
of material misstatement.  An audit includes examining, on a test basis, 
evidence supporting the amounts and disclosures in the financial statements.  
An audit also includes assessing the accounting principles used and 
significant estimates made by management, as well as evaluating the overall 
financial statement presentation.  We believe that our audits provide a 
reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above 
present fairly, in all material respects, the financial position of 
Merchants Bancshares, Inc. and subsidiaries as of December 31, 1997 and 
1996, and the results of their operations and their cash flows for each of 
the three years in the period ended December 31, 1997, in conformity with 
generally accepted accounting principles.





Boston, Massachusetts
January 21, 1998


                         Merchants Bancshares, Inc.
                         Consolidated Balance Sheets

<TABLE>
<CAPTION>
                                                            December 31,   December 31,
(In thousands except share and per share data)                  1997           1996
---------------------------------------------------------------------------------------
<S>                                                           <C>            <C>
ASSETS
  Cash and Due from Banks                                     $ 20,139       $ 29,726
  Investments:
    Debt Securities Available for Sale                          44,241         57,656
    Debt Securities Held to Maturity                           111,458         86,904
    Trading Securities                                           1,031            500
    Marketable Equity Securities                                    --            230
-------------------------------------------------------------------------------------
      Total Investments                                        156,730        145,290
-------------------------------------------------------------------------------------
  Loans                                                        390,388        387,233
  Reserve for Possible Loan Losses                              15,831         15,700
-------------------------------------------------------------------------------------
      Net Loans                                                374,557        371,533
-------------------------------------------------------------------------------------
  Federal Home Loan Bank Stock                                   2,296          2,841
  Bank Premises and Equipment, Net                              13,428         13,791
  Investments in Real Estate Limited Partnerships                1,972          2,499
  Other Real Estate Owned                                          591          1,925
  Other Assets                                                  14,539         14,031
-------------------------------------------------------------------------------------
      Total Assets                                            $584,252       $581,636
=====================================================================================
LIABILITIES
  Deposits:
    Demand                                                    $ 76,712       $ 80,576
    Savings, NOW and Money Market Accounts                     267,396        263,882
    Time Deposits $100 thousand and Greater                     23,307         20,370
    Other Time                                                 138,429        143,452
-------------------------------------------------------------------------------------
      Total Deposits                                           505,844        508,280
-------------------------------------------------------------------------------------
  Demand Note Due U.S. Treasury                                  4,000          3,599
  Other Short-Term Borrowings                                    4,000          6,000
  Other Liabilities                                             11,057         11,087
  Long-Term Debt                                                 6,415          6,420
-------------------------------------------------------------------------------------
      Total Liabilities                                        531,316        535,386
-------------------------------------------------------------------------------------
Commitments and Contingencies (Note 13)
STOCKHOLDERS' EQUITY
  Preferred Stock Class A Non-Voting
   Authorized - 200,000, Outstanding 0                              --             --
  Preferred Stock Class B Voting
   Authorized - 1,500,000, Outstanding 0                            --             --
  Common Stock, $.01 Par Value                                      44             44
    Shares Authorized                  7,500,000
    Outstanding:    Current Period     4,290,698
                    Previous Period    4,290,342
    Treasury Stock (At Cost):  143,922 current period
                               144,278 prior period             (2,220)        (2,038)
    Capital in Excess of Par Value                              33,223         33,155
    Retained Earnings                                           21,537         14,845
    Unearned Compensation-Restricted Stock Awards                  (10)            --
    Unrealized Gain on Securities Available For Sale, Net          362            244
-------------------------------------------------------------------------------------
      Total Stockholders' Equity                                52,936         46,250
-------------------------------------------------------------------------------------
      Total Liabilities and Stockholders' Equity              $584,252       $581,636
=====================================================================================
Book Value Per Common Share                                   $  11.95       $  10.78
=====================================================================================
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements


                         Merchants Bancshares, Inc.
                    Consolidated Statements of Operations

<TABLE>
<CAPTION>
                                                                  Years Ended December 31,
(In thousands except per share data)                            1997       1996       1995
--------------------------------------------------------------------------------------------
<S>                                                            <C>        <C>        <C>
INTEREST AND DIVIDEND INCOME:
  Interest and Fees on Loans                                   $38,543    $39,953    $46,067
  Interest and Dividends on Investments:
    U.S. Treasury and Agency Obligations                         9,433      7,588      4,525
    Other                                                          182        463        723
--------------------------------------------------------------------------------------------
Total Interest and Dividend Income                              48,158     48,004     51,315
--------------------------------------------------------------------------------------------
INTEREST EXPENSE:
  Savings, NOW and Money Market Accounts                         8,403      8,216      9,077
  Time Deposits $100 Thousand and Greater                        1,428      1,397      1,433
  Other Time Deposits                                            7,485      8,112      8,981
  Other Borrowed Funds                                             509        345        257
  Debt                                                             413        602      3,254
--------------------------------------------------------------------------------------------
Total Interest Expense                                          18,238     18,672     23,002
--------------------------------------------------------------------------------------------
Net Interest Income                                             29,920     29,332     28,313
  Provision for Possible Loan Losses                            (1,862)     3,150     12,100
--------------------------------------------------------------------------------------------
Net Interest Income after Provision for Possible Loan Losses    31,782     26,182     16,213
--------------------------------------------------------------------------------------------
NONINTEREST INCOME:
  Trust Company Income                                           1,635      1,493      1,796
  Service Charges on Deposits                                    3,075      3,347      3,184
  Merchant Discount Fees                                         1,537      1,696      1,861
  Gains on Sale of Investment Securities, Net                      784         33        352
  Gain on Curtailment of Pension Plan                               --         --      1,563
  FDIC Assistance Received-Loss Sharing                             --        407      2,951
  Other                                                            885      2,387      1,059
--------------------------------------------------------------------------------------------
Total Noninterest Income                                         7,916      9,363     12,766
--------------------------------------------------------------------------------------------
NONINTEREST EXPENSES:
  Salaries and Wages                                             8,682      8,222     10,729
  Employee Benefits                                              1,992      1,791      2,705
  Occupancy Expense                                              2,171      2,054      2,178
  Equipment Expense                                              2,325      2,024      2,069
  Legal and Professional Fees                                    3,888      1,961      1,617
  Provision for Impairmement of Investment Security                229         --         --
  Losses on and Writedowns of Other Real Estate Owned              314      3,400      2,987
  Equity in Losses of Real Estate Limited Partnerships             641        846        646
  Losses and Write-downs of Segregated Assets                       --        407      2,951
  Reengineering Expenses and Related Consultants' Fees              --         --      4,056
  Loss (Gain) on Disposition of Fixed Assets                     1,088       (565)        --
  Other                                                          7,152      7,349      6,668
--------------------------------------------------------------------------------------------
Total Noninterest Expenses                                      28,482     27,489     36,606
--------------------------------------------------------------------------------------------
Income (Loss) Before Provision (Benefit) for Income Taxes       11,216      8,056     (7,627)
Provision (Benefit) for Income Taxes                             2,383      1,832     (3,785)
--------------------------------------------------------------------------------------------
NET INCOME (LOSS)                                              $ 8,833    $ 6,224    $(3,842)
============================================================================================
BASIC EARNINGS (LOSS) PER COMMON SHARE                         $  2.00    $  1.45    $ (0.90)
DILUTED EARNINGS (LOSS) PER COMMON SHARE                          1.99       1.45      (0.90)
</TABLE>

The accompanying notes are an integral part of these consolidated financial 
statements.


                         Merchants Bancshares, Inc.
         Consolidated Statements of Changes in Stockholders' Equity
      For Each of the Three Years in the Period Ended December 31, 1997

<TABLE>
<CAPTION>
                                                                                                   Net Unrealized
                                                                                      Unearned      Appreciation
                                             Capital in                            Compensation-   (Depreciation)
                                    Common    Excess of   Retained      Treasury     Restricted    of Investment
(In thousands)                       Stock    Par Value   Earnings       Stock      Stock Awards     Securities      Total
---------------------------------------------------------------------------------------------------------------------------

<S>                                   <C>      <C>        <C>           <C>             <C>            <C>          <C>
Balance, December 31, 1994            $42      $30,647    $12,463       $  (179)        $ --           $ (674)      $42,299
  Net Loss                             --           --     (3,842)           --           --               --        (3,842)
  Sale of Treasury Stock               --          (44)        --           179           --               --           135
  Purchase of Treasury Stock           --           --         --        (2,038)          --               --        (2,038)
  Issuance of Common Stock              2        2,552         --            --           --               --         2,554
  Change in Net Unrealized 
   Appreciation (Depreciation) of
   Securities Available for Sale,     
   Net of Tax                          --           --         --            --           --            1,141         1,141
---------------------------------------------------------------------------------------------------------------------------

Balance, December 31, 1995             44       33,155      8,621        (2,038)          --              467        40,249
  Net Income                           --           --      6,224            --           --               --         6,224
  Change in Net Unrealized 
   Appreciation (Depreciation) of
   Securities Available for Sale,
   Net of Tax                          --           --         --            --           --             (359)         (359)
  Change in Net Unrealized 
   Appreciation of Securities
   Transferred to the Held to
   Maturity Portfolio, Net of Tax      --           --         --            --           --              136           136
---------------------------------------------------------------------------------------------------------------------------

Balance, December 31, 1996             44       33,155     14,845        (2,038)          --              244        46,250
  Net Income                           --           --      8,833            --           --               --         8,833
  Purchase of Treasury Stock           --           --         --        (1,390)          --               --        (1,390)
  Sales of Treasury Stock              --          219         --         1,015           --               --         1,234
  Issuance of Stock under 
   Employee Stock Option Plans         --         (151)        --           193           --               --            42
  Dividends Paid                       --           --     (2,141)           --           --               --        (2,141)
  Unearned Compensation--
   Restricted Stock Awards             --           --         --            --          (10)              --           (10)
  Change in Net Unrealized
   Appreciation (Depreciation) of      
   Securities Available for Sale,
   Net of Tax                          --           --         --            --           --              108           108
  Change in Net Unrealized 
   Appreciation of Securities 
   Transferred to the Held to 
   Maturity Portfolio, Net of Tax      --           --         --            --           --               10            10
---------------------------------------------------------------------------------------------------------------------------

Balance, December 31, 1997            $44      $33,223    $21,537       $(2,220)        $(10)          $  362       $52,936
</TABLE>

The accompanying notes are an integral part of these consolidated financial 
statements.


                         Merchants Bancshares, Inc.
                    Consolidated Statement of Cash Flows

<TABLE>
<CAPTION>
                                                                              Years Ended December 31,
(In thousands)                                                             1997        1996        1995
---------------------------------------------------------------------------------------------------------
<S>                                                                       <C>        <C>         <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income (Loss)                                                         $ 8,833    $  6,224    $ (3,842)
Adjustments to Reconcile Net Income (Loss) to Net Cash Provided by
 Operating Activities:
  Provision for Possible Loan Losses                                       (1,862)      3,150      12,100
  Provision for Possible Losses on Other Real Estate Owned                     34       2,495       1,365
  Provision for Impairment of Investment Security                             229          --          --
  Provision for Depreciation and Amortization                               2,377       2,667       4,358
  Deferred (Prepaid) Income Taxes                                             884      (1,475)       (693)
  Net Gains on Sales of Investment Securities                                (784)        (33)       (352)
  Net Gains on Sales of Loans and Leases                                      (11)       (505)       (464)
  Net (Gains) Losses on Sales of Premises and Equipment                     1,088        (565)       (223)
  Net Gains on Sales of Other Real Estate Owned                              (138)       (328)         --
  Equity in Losses of Real Estate Limited Partnerships                        641         846         646
Changes in Assets and Liabilities:
  (Increase) Decrease in Interest Receivable                                  (63)        936       1,099
  Increase (Decrease) in Interest Payable                                      14        (313)        170
  Decrease in Other Assets                                                 (1,328)      7,002       8,811
  Increase (Decrease) in Other Liabilities                                    (44)       (724)      1,567
---------------------------------------------------------------------------------------------------------
      Net Cash Provided by Operating Activities                             9,870      19,377      24,542
---------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
  Proceeds from Sales of Investment Securities Available for Sale          18,907      42,522      50,377
  Proceeds from Maturities of Investment Securities Available for Sale     13,985      16,000      59,000
  Proceeds from Sales of Loans and Leases                                   3,131      19,576      35,574
  Proceeds from Sales of FHLB Stock                                           545         334       3,682
  Proceeds from Sales of Premises and Equipment                                 6       1,818         328
  Proceeds from Sales of Other Real Estate Owned                            2,112       6,144       8,378
  Purchases of Available for Sale Investment Securities                   (10,005)   (105,929)   (102,823)
  Purchases of Held to Maturity Investment Securities                     (33,278)         --          --
  Principal Repayments in Excess of (Less than) Loan Originations          (4,364)     37,292       4,030
  Investments in Real Estate Limited Partnerships                            (102)       (111)         --
  Purchases of Premises and Equipment                                      (4,099)     (4,688)       (793)
---------------------------------------------------------------------------------------------------------
      Net Cash Provided by (Used in) Investing Activities                 (13,162)     12,958      57,753
---------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
  Net Decrease in Deposits                                                 (2,436)    (36,234)    (37,710)
  Net Increase (Decrease) in Other Borrowed Funds                          (1,599)      4,263     (12,959)
  Principal Payments on Debt                                                   (5)     (9,005)    (28,805)
  Cash Dividends Paid                                                      (2,141)         --          --
  Acquisition of Treasury Stock                                            (1,390)         --      (2,038)
  Issuance of Common Stock                                                     --          --       2,554
  Proceeds From Exercise of Employee Stock Options                             42          --          --
  Sale of Treasury Stock                                                    1,234          --         179
---------------------------------------------------------------------------------------------------------
      Net Cash Used in Financing Activities                                (6,295)    (40,976)    (78,779)
---------------------------------------------------------------------------------------------------------
Increase (Decrease) in Cash and Cash Equivalents                           (9,587)     (8,641)      3,516
Cash and Cash Equivalents Beginning of Year                                29,726      38,367      34,851
---------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents End of Period                                   $20,139    $ 29,726    $ 38,367
=========================================================================================================
Total Interest Payments                                                   $18,224    $ 18,985    $ 22,831
Total Income Tax Payments                                                   3,820          --          --
Transfer of Loans and Premises to Other Real Estate Owned                     515       2,815       2,777
Transfer of Securities Available for Sale to Held to Maturity Portfolio        --      87,509          --
</TABLE>

The accompanying notes are an integral part of these consolidated financial 
statements.











                         Merchants Bancshares, Inc.
                 Notes to Consolidated Financial Statements
                              December 31, 1997

(1)   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of 
Merchants Bancshares, Inc. (the "Company") and its wholly owned 
subsidiaries, Merchants Bank (the "Bank") (including the Bank's wholly owned 
subsidiaries Merchants Trust Company (the "Trust Company"), and certain 
trusts; Queneska Capital Corporation, formerly a wholly owned subsidiary of 
the Bank was dissolved in December 1997), and Merchants Properties, Inc., 
after elimination of all material intercompany accounts and transactions. 
The Bank and the Trust Company offer a full range of deposit, loan, cash 
management and trust services to meet the financial needs of individual 
consumers, businesses and municipalities at 33 full-service banking 
locations throughout the State of Vermont.

Use of Estimates in Preparation of Financial Statements

The preparation of financial statements in conformity with generally 
accepted accounting principles requires management to make estimates and 
assumptions that affect the reported amounts of assets and liabilities and 
disclosure of contingent assets and liabilities at the date of the financial 
statements and the reported amounts of income and expenses during the 
reporting periods. Operating results in the future could vary from the 
amounts derived from management's estimates and assumptions.

Investment Securities

The Company classifies certain of its investments in debt securities as held 
to maturity which are carried at amortized cost if the Company has the 
positive intent and ability to hold such securities to maturity. Investments 
in debt securities that are not classified as held to maturity and equity 
securities that have readily determinable fair values are classified as 
trading securities or available for sale securities. Trading securities are 
investments purchased and held principally for the purpose of selling in the 
near term; available for sale securities are investments not classified as 
trading or held to maturity. Available for sale securities are carried at 
market value measured at each reporting date. The resulting unrealized gain 
or loss is reflected in Stockholders' Equity net of the associated tax 
effect.

Transfers from securities available for sale to securities held to maturity 
are recorded at the securities' fair values on the date of the transfer. Any 
net unrealized gains or losses continue to be reported as a separate 
component of stockholders' equity, on a net of tax basis as long as the 
securities are carried in the held to maturity portfolio, and are amortized 
over the estimated remaining life of the transferred securities as an 
adjustment to yield in a manner consistent with the amortization of premiums 
and discounts.

Dividend and interest income, including amortization of premiums and 
discounts, is recorded in earnings for all categories of investment 
securities. Discounts and premiums related to debt securities are amortized 
using a method which approximates the level-yield method. The gain or loss 
recognized on the sale of an investment security is based upon the adjusted 
cost of the specific security.

Management reviews all reductions in fair value below book value to 
determine whether the impairment is other than temporary. If the impairment 
is determined to be other than temporary in nature, the carrying value of 
the security is written down to the appropriate level by a charge to 
earnings.

Loan Origination and Commitment Fees

Loan origination and commitment fees and certain direct loan origination 
costs are deferred and amortized over the lives of the related loans. Net 
deferred origination fees were $859 thousand and $947 thousand at December 
31, 1997 and 1996, respectively.

Premises and Equipment

Premises and equipment are stated at cost, less accumulated depreciation and 
amortization. Depreciation and amortization are provided using straight-line 
and accelerated methods at rates that depreciate the original cost of the 
premises and equipment over their estimated useful lives. Expenditures for 
maintenance, repairs and renewals of minor items are generally charged to 
expense as incurred. When premises and equipment are replaced, retired, or 
deemed no longer useful they are valued at estimated selling price less 
costs to sell, and to the extent the net book value exceeds this value the 
difference is charged to current earnings.

Gains and Losses on Sales of Loans

Gains and losses on sales of loans are recognized based upon the difference 
between the selling price and the carrying amount of loans sold. Gains and 
losses are adjusted for excess servicing rights resulting from the sale of 
certain loans with servicing rights retained. Excess servicing rights are 
recorded at the net present value of estimated future servicing revenue when 
such amounts are greater than normal servicing fees. Deferred excess 
servicing is amortized over the period of estimated net servicing income. 
Origination fees collected, net of commitment fees paid in connection with 
the sales of loans and net of the direct cost of originating the loans, are 
recognized at the time such loans are sold.

Income Taxes

Deferred tax assets and liabilities are reflected at currently enacted 
income tax rates applicable to the period in which the deferred tax assets 
or liabilities are expected to be realized or settled. As changes in tax 
laws or rates are enacted, deferred tax assets and liabilities are adjusted 
through the provision for income taxes. Low-income housing tax credits are 
recognized in the year in which they are earned.

Investments in Real Estate Limited Partnerships

The Bank has investments in various real estate limited partnerships that 
acquire, develop, own and operate low and moderate-income housing. The 
Bank's ownership interest in these limited partnerships varies from 35% to 
99% as of December 31, 1997. The Bank consolidates the financial statements 
of the limited partnership in which the Company is the general partner and 
is actively involved in management and has a controlling interest. The Bank 
accounts for investments in limited partnerships where the Bank neither 
actively participates nor has a controlling interest under the equity method 
of accounting.

Management periodically reviews the results of operations of the various 
real estate limited partnerships to determine if the partnerships generate 
sufficient operating cash flow to fund their current obligations. In 
addition, management reviews the current value of the underlying property 
compared to the outstanding debt obligations. If it is determined that the 
investment suffers from a permanent impairment, the carrying value is 
written down to the estimated realizable value. The Bank recognized losses 
of $97 thousand due to the impairment of an investment in a real estate 
limited partnership in 1996.

Cash and Cash Equivalents

Cash and cash equivalents consist of cash on hand, amounts due from banks 
and federal funds sold in the accompanying consolidated statements of cash 
flows. At December 31, 1997 and 1996, cash and cash equivalents included 
$2.2 million and $4.7 million, respectively, held to satisfy the reserve 
requirements of the Federal Reserve Bank.

Other Real Estate Owned

Collateral acquired through foreclosure is recorded at the lower of cost or 
fair value, less estimated costs to sell, at the time of acquisition. Bank 
premises held for sale are recorded at the lower of cost or market, less 
estimated costs to sell, at the date of transfer. A valuation allowance is 
established for the estimated costs to sell and is charged to expense. 
Subsequent changes in the fair value of other real estate owned are 
reflected as a write-down and charged to expense. Net operating income or 
expense related to foreclosed property and Bank premises held for sale is 
included in noninterest expense in the accompanying consolidated statements 
of operations. There are inherent uncertainties in the assumptions with 
respect to the estimated fair value of other real estate owned. Because of 
these inherent uncertainties, the amount ultimately realized on other real 
estate owned ("OREO") may differ from the amounts reflected in the 
consolidated financial statements. The Bank recognized losses due to 
additions to the valuation allowance of $34 thousand, $2,495 thousand and 
$1,365 thousand during 1997, 1996 and 1995, respectively. At December 31, 
1997 the balance in the OREO portfolio, net of valuation allowances, 
consisted of foreclosed real estate of $36 thousand and Bank premises held 
for sale of $555 thousand.

Intangible Assets

Premiums paid for the purchase of core deposits are recorded as other assets 
and amortized on a straight-line method over the estimated period of 15 
years. Management reviews the value of the intangible asset by comparing 
purchased deposit levels to the current level of acquired deposits in the 
branches purchased. If any significant deposit runoff has occurred and is 
determined to be permanent in nature, the asset is written down accordingly.

Mortgage Servicing Rights

On January 1, 1996, the Company adopted Statement of Financial Accounting 
Standards No. 122 "Accounting for Mortgage Servicing Rights" ("SFAS No. 
122"). SFAS No. 122 requires that entities engaging in mortgage banking 
activities recognize the rights to service mortgage loans for others, 
regardless of the manner in which the servicing rights are acquired, as 
separate assets when the related loans are sold and the mortgage servicing 
rights are retained. The amount capitalized is based on an allocation of the 
total cost of the mortgage loans to the mortgage servicing rights and the 
loan (without the mortgage servicing rights) based on their relative fair 
values. In addition, capitalized mortgage servicing rights are required to 
be assessed for impairment based on the relative fair value of those rights. 
Effective January 1, 1997, SFAS No. 125, "Accounting for Transfers and 
Servicing of Financial Assets and Extinguishments of Liabilities," ("SFAS 
No. 125"), superseded SFAS No. 122. SFAS No. 127 "Deferral of the Effective 
Date of Certain Provisions of FASB Statement No. 125," is effective for 
transactions occurring after December 31, 1996.

On January 1, 1997, the Company adopted SFAS No. 125. This statement 
requires transfers of financial assets in which the Bank surrenders control 
over those financial assets to be accounted for as a sale to the extent that 
consideration other than beneficial interests in the transferred assets is 
received in exchange. Each time a bank undertakes an obligation to service 
financial assets it recognizes either a servicing asset or a servicing 
liability for that contract, unless it securitizes the asset, retains all of 
the securities, and classifies them as debt securities held to maturity. The 
implementation of this statement has not had a material effect on the 
Company's results of operations of financial condition. The carrying value 
of capitalized mortgage servicing rights as of December 31, 1997 and 1996 
were $85 thousand and $118 thousand, respectively.

Stock-based Compensation Plans

The Company applies Accounting Principles Bulletin ("APB") No. 25, 
"Accounting for Stock Issued to Employees" and related interpretations in 
accounting for its stock-based compensation plans. Accordingly, no 
accounting recognition is given to stock options granted at fair market 
value until they are exercised. Upon exercise, net proceeds, including tax 
benefits realized, are credited to equity. Refer to Note 6 for additional 
information.

Earnings Per Share

In 1997, The Company adopted the provisions of SFAS N0. 128, "Earnings Per 
Share" ("SFAS No. 128"). This statement was issued by the Financial 
Accounting Standards Board ("FASB") in March 1997 and establishes the 
standards for computing and presenting earnings per share ("EPS") and 
applies to entities with publicly held common stock or potential common 
stock. This statement replaces the presentation of primary EPS with a 
presentation of basic EPS. It also requires dual presentation of basic and 
diluted EPS on the face of the income statement for all entities with 
complex capital structures and requires a reconciliation of the numerators 
and denominators of the basic and diluted EPS computations for all prior-
period EPS data presented. Refer to Note 11 for additional information.

Accounting for Impairment of Long-Lived Assets

In 1996, the Company adopted SFAS No. 121, "Accounting for the Impairment of 
Long-Lived Assets and for Long-Lived Assets To Be Disposed Of." This 
statement requires a review for impairment of long-lived assets and certain 
identifiable intangibles to be held and used by an entity when events or 
changes in circumstances indicate that the carrying amount of the assets may 
not be recoverable. If the sum of the undiscounted future cash flows 
expected to result from the use and eventual disposition of the asset is 
less than the carrying amount of the asset, an impairment loss is 
recognized. Measurement of the impairment loss is determined by comparing 
the carrying amount of the asset to its fair value. For certain long-lived 
assets to be disposed of, the cost to sell the asset is deducted from the 
asset's fair value in determining the impairment loss, if any. This 
statement does not apply to financial instruments, core deposit intangibles, 
mortgage and other servicing rights, or deferred tax assets.

Comprehensive Income

In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive 
Income". This statement establishes standards for reporting and display of 
comprehensive income and its components (revenues, expenses, gains and 
losses). Components of comprehensive income are net income and all other 
non-owner changes in equity. This statement requires that an enterprise (a) 
classify items of other comprehensive income by their nature in a financial 
statement and (b) display the accumulated balance of other comprehensive 
income separately from retained earnings and additional paid-in capital in 
the equity section of a statement of financial position. This statement is 
effective for the Company's financial statements issued for the fiscal year 
ended December 31, 1998. Reclassification of financial statements for 
earlier periods provided for comparative purposes is required.

Segment Information

In June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments of 
an Enterprise and Related Information" ("SFAS No. 131"). This statement 
establishes the standards for reporting information about segments in annual 
and interim financial statements. SFAS No. 131 introduces a new model for 
segment reporting; the "management approach". The management approach is 
based on the way the chief operating decision-maker organizes segments 
within a company for making operating decisions and assessing performance. 
Reportable segments are based on products and services, geography, legal 
structure, management structure--any manner in which management 
disaggregates a company. This statement is effective and will be adopted for 
the Company's financial statements for the fiscal year ended December 31, 
1998 and requires the restatement of previously reported segment information 
for all periods presented.

Reclassification

Certain amounts reported for prior periods have been reclassified to be 
consistent with the current period presentation.

(2)   INVESTMENT SECURITIES

Investments in debt securities are classified as trading, available for sale 
or held to maturity as of December 31, 1997 and 1996. The amortized cost and 
fair values of the debt securities classified as available for sale and held 
to maturity as of December 31, 1997 and 1996 are as follows:

SECURITIES AVAILABLE FOR SALE:

<TABLE>
<CAPTION>
                                            Gross        Gross
                              Amortized   Unrealized   Unrealized    Fair
                                Cost        Gains        Losses     Value
---------------------------------------------------------------------------
1997                                         (In thousands)
---------------------------------------------------------------------------
<S>                            <C>           <C>          <C>       <C>
U.S. Agency Obligations        $31,058       $271         $--       $31,329
Mortgage-backed securities      12,825        105          18        12,912
---------------------------------------------------------------------------
                               $43,883       $376         $18       $44,241
===========================================================================

<CAPTION>
                                            Gross        Gross    
                              Amortized   Unrealized   Unrealized    Fair
                                Cost        Gains        Losses     Value
---------------------------------------------------------------------------
1996                                         (In thousands)
---------------------------------------------------------------------------
<S>                            <C>           <C>          <C>       <C>
U.S. Treasury Obligations      $18,146       $ 14         $36       $18,124
U.S. Agency Obligations         23,099        178          --        23,277
Mortgage-backed Securities      16,218         97          60        16,255
---------------------------------------------------------------------------
                               $57,463       $289         $96       $57,656
===========================================================================
</TABLE>

SECURITIES HELD TO MATURITY:

<TABLE>
<CAPTION>
                                            Gross        Gross
                              Amortized   Unrealized   Unrealized    Fair
                                Cost        Gains        Losses     Value
---------------------------------------------------------------------------
1997                                         (In thousands)
---------------------------------------------------------------------------
<S>                           <C>           <C>          <C>       <C>
U.S. Treasury Obligations     $    200      $   --       $ --      $    200
U.S. Agency Obligations         12,526          94          4        12,616
Mortgage-backed Securities      98,732         960         41        99,651
---------------------------------------------------------------------------
                              $111,458      $1,054       $ 45      $112,467
===========================================================================

<CAPTION>
                                            Gross        Gross
                              Amortized   Unrealized   Unrealized    Fair
                                Cost        Gains        Losses     Value
---------------------------------------------------------------------------
1996                                         (In thousands)
---------------------------------------------------------------------------
<S>                           <C>             <C>        <C>       <C>
U.S. Agency Obligations       $  2,504        $--        $ 52      $  2,452
Mortgage-backed Securities      84,400         23         871        83,552
---------------------------------------------------------------------------
                              $ 86,904        $23        $923      $ 86,004
===========================================================================
</TABLE>

Marketable equity securities are classified as available for sale at 
December 31, 1997 and 1996 and are stated at their fair value of $0 and $230 
thousand, respectively. Gross unrealized losses on equity securities were 
$30 thousand at December 31, 1997 and 1996.

The fair value of securities held for trading was $1,031 thousand and $500 
thousand at December 31, 1997 and 1996 respectively. Unrealized gains on 
securities held for trading were $267 thousand and $0 as of December 31, 
1997 and 1996, respectively.

The contractual maturities of all debt securities held at December 31, 1997 
are as follows:

<TABLE>
<CAPTION>
                                                  Amortized     Fair
     (In thousands)                                 Cost       Value
     -----------------------------------------------------------------
     <S>                                          <C>         <C>
     Due within one year                          $  4,021    $  4,038
     Due after one year through five years          29,758      30,083
     Due after five years through ten years         30,470      30,869
     Due after ten years                            91,092      91,718
     -----------------------------------------------------------------
                                                  $155,341    $156,708
     =================================================================
</TABLE>

Proceeds from sales of available for sale debt securities, including 
principal repayments on mortgage-backed securities, were $18.9 million and 
$42.5 million during 1997 and 1996, respectively. Gross gains of $840 
thousand, $120 thousand and $660 thousand and gross losses of $56 thousand, 
$87 thousand and $308 thousand were realized from sales of debt and equity 
securities in 1997, 1996 and 1995, respectively.

On November 29, 1996, $87.5 million of securities available for sale were 
transferred to the held to maturity portfolio. Net unrealized gains of $202 
thousand associated with these securities are being amortized over the 
remaining lives of the individual securities.

At December 31, 1997, securities with a face value of $14.3 million were 
pledged to secure public deposits, and for other purposes required by law.

(3)   LOANS

The composition of the loan portfolio at December 31, 1997 and 1996 is as 
follows:

<TABLE>
<CAPTION>
       (In thousands)                             1997        1996
       -------------------------------------------------------------
       <S>                                      <C>         <C>
       Commercial, Financial and Agricultural   $ 73,523    $ 61,091
       Real Estate--Commercial                   155,983     178,780
       Real Estate--Residential                  136,305     128,577
       Real Estate--Construction                   8,695       3,420
       Installment Loans to individuals           15,450      14,831
       All Other Loans (including overdrafts)        432         534
       -------------------------------------------------------------
                                                $390,388    $387,233
       =============================================================
</TABLE>

In connection with an acquisition, the Bank received financial assistance 
(loss sharing) with respect to certain acquired loans charged-off by the 
Bank during the three-year period ended June 30, 1996. The FDIC reimbursed 
the Bank, on a quarterly basis, 80% of net charge-offs and certain expenses 
related to loans subject to loss sharing aggregating $41.1 million. Charge-
offs and eligible expenses on Segregated Assets, net of recoveries, 
aggregated $2.2 million and $3.7 million for 1996 and 1995. The Bank 
received $407 thousand and $2,951 thousand from the FDIC for eligible 
charge-offs, net of recoveries and eligible expenses, related to 1996 and 
1995, respectively, in accordance with the loss sharing arrangement.
 
Expenses and charge-offs relating to the Segregated Assets had an 
insignificant effect on the Bank's noninterest expenses for 1996 and 1995. 
The Bank's share of the charge-offs was charged to the allowance for losses 
on the Segregated Assets (such allowance being a component of the Bank's 
overall allowance for loan losses), which was established in conjunction 
with the acquisition. All future losses on these loans will be charged to 
the Bank's allowance for loan losses.  The Bank continues to be obligated to 
compensate the FDIC for a portion of recoveries received through June 1998 
on loans previously charged off and for which the Bank received 
reimbursement from the FDIC. The Bank reimbursed the FDIC $133 thousand for 
such recoveries during 1997.

The Bank originates primarily residential real estate loans, commercial and 
installment loans, and to a lesser extent commercial real estate loans to 
customers throughout the state of Vermont. There were no loans held for sale 
at December 31, 1997 and 1996. Substantially all of the Bank's loan 
portfolio is based in the state of Vermont. There are no known significant 
industry concentrations in the loan portfolio. Loans serviced for others at 
December 31, 1997 and 1996 amounted to $230 million and $313 million, 
respectively.

The reserve for possible loan losses is based on management's estimate of 
the amount required to reflect the risks in the loan portfolio, based on 
circumstances and conditions known or anticipated at each reporting date. 
There are inherent uncertainties with respect to the final outcome of 
certain of the Bank's loans and nonperforming assets. Because of these 
inherent uncertainties, actual losses may differ from the amounts reflected 
in these consolidated financial statements. Factors considered in evaluating 
the adequacy of the reserve include previous loss experience, current 
economic conditions and their effect on the borrowers, the performance of 
individual loans in relation to contract terms and estimated fair values of 
properties to be foreclosed. Losses are charged against the reserve for loan 
losses when management believes that the collectibility of principal is 
doubtful.

Key elements of the above estimates, including those used in independent 
appraisals, are dependent upon the economic conditions prevailing at the 
time of the estimates. Accordingly, uncertainty exists as to the final 
outcome of certain of the valuation judgments as a result of the difficult 
and unpredictable conditions in the region. The inherent uncertainties in 
the assumptions relative to the projected sales prices or rental rates may 
result in the ultimate realization of amounts on certain loans that are 
different from the amounts reflected in these consolidated financial 
statements.

An analysis of the reserve for possible loan losses for the years ended 
December 31, 1997 and 1996 is as follows:

<TABLE>
<CAPTION>
         (In thousands)                         1997        1996
         ---------------------------------------------------------
         <S>                                  <C>         <C>
         Balance, Beginning of Year           $15,700     $16,235
         Provision for Possible Loan Losses    (1,862)      3,150
         Loans Charged Off                     (1,696)     (5,135)
         Recoveries                             3,689       1,450
         ---------------------------------------------------------
         Balance, End of Year                 $15,831     $15,700
         =========================================================
</TABLE>

Loan recoveries include $133 thousand and $247 thousand on Segregated Assets 
for 1997 and 1996, respectively. Loans charged off include $158 thousand on 
segregated assets for 1996.

The allowance for possible loan losses related to loans that are identified 
as impaired is based on discounted cash flows using the loan's effective 
interest rate or the fair value of the collateral for certain collateral 
dependent loans. The Company has determined that commercial and commercial 
real estate loans recognized by the Company as nonaccrual, loans past due 
over 90 days and still accruing, restructured troubled debt and certain 
internally adversely classified loans are generally equivalent to impaired 
loans.

Total impaired loans at December 31, 1997 and 1996 with a related allowance 
were $4.8 million and $8.4 million respectively, and the allowance 
associated with such loans was $665 thousand and $875 thousand, 
respectively. Interest payments on impaired loans are generally recorded as 
principal reductions if the remaining loan balance is not expected to be 
paid in full. If full collection of the remaining loan balance is expected, 
payments are recognized as interest income on a cash basis. During 1997 and 
1996, the Company recorded interest income on impaired loans of 
approximately $394 thousand and $505 thousand, respectively. The average 
balance of impaired loans was $7.9 million in 1997 and $16.4 million in 
1996.

Nonperforming assets at December 31, 1997 and 1996 were as follows:

<TABLE>
<CAPTION>
             (In thousands)                     1997      1996
             --------------------------------------------------
             <S>                               <C>       <C>
             Nonaccrual loans                  $2,686    $4,091
             Restructured Loans                   215     2,403
             Loans Past Due 90 Days or More
              and Still Accruing Interest         403       216
             --------------------------------------------------
             Total Nonperforming Loans          3,304     6,710
             Other Real Estate Owned, Net         591     1,925
             --------------------------------------------------
                                               $3,895    $8,635
             ==================================================
</TABLE>

The Bank had $215 thousand and $2,403 thousand of restructured loans that 
were performing in accordance with the modified agreement at December 31, 
1997 and 1996, respectively.

The Bank's policy is to discontinue the accrual of interest and reverse 
uncollected interest receivable on loans when scheduled payments become 
contractually past due in excess of 90 days or, in the judgment of 
management, the ultimate collectibility of principal or interest becomes 
doubtful.

The amount of interest which was not earned but which would have been earned 
had the nonaccrual and restructured loans performed in accordance with their 
original terms and conditions was approximately $395 thousand, $1,493 
thousand and $3,466 thousand in 1997, 1996 and 1995, respectively.

During 1997, the Bank consumated two transactions involving sales of loans, 
including certain impaired loans. The aggregate net book balue of loans sold 
was approximately $2.7 million. The Bank recognized a recovery of $396 
thousand from the sale of these loans. During 1996, the Bank consummated 
three such transactions, including certain impaired loans. The aggregate net 
book value of loans sold in 1996 was approximately $13.2 million, resulting 
in a total loss on sales of $556 thousand, which was charged against the 
allowance for possible loan losses. All loans were sold without recourse.

An analysis of loans to directors, executive officers and associates of such 
persons for the year ended December 31, 1997 is as follows:

<TABLE>
<CAPTION>
                  (In thousands)    
                  --------------------------------------
                  <S>                             <C>
                  Balance, December 31, 1996      $8,802
                  Additions                          732
                  Repayments                         584
                  --------------------------------------
                  Balance, December 31, 1997      $8,950
                  ======================================
</TABLE>

It is the policy of the Bank to grant such loans on substantially the same 
terms, including interest rates and collateral, as those prevailing for 
comparable lending transactions with other persons. The December 31, 1996 
balance has been adjusted to reflect changes in status of directors and 
executive officers during 1997.

(4)   PREMISES AND EQUIPMENT

The components of premises and equipment included in the accompanying 
consolidated balance sheets are as follows:

<TABLE>
<CAPTION>
       (In thousands)                           1997       1996
       ---------------------------------------------------------
       <S>                                    <C>        <C>
       Land and Buildings                     $12,601    $12,139
       Leasehold Improvements                   1,288        962
       Furniture, Equipment, and Software      10,617     14,223
       ---------------------------------------------------------
                                               24,506     27,324
       Less: Accumulated Depreciation
        and Amortization                       11,078     13,533
       ---------------------------------------------------------
                                              $13,428    $13,791
       =========================================================
</TABLE>

Depreciation and amortization expense related to premises and equipment 
amounted to $2.0 million, $1.7 million and $1.9 million in 1997, 1996, and 
1995, respectively.

The Bank leases certain properties for branch operations. Rent expense on 
these properties totaled $263 thousand, $240 thousand and $213 thousand for 
the years ended December 31, 1997, 1996 and 1995, respectively. Minimum 
lease payments for these properties subsequent to December 31, 1997 are as 
follows: 1998 - $220 thousand; 1999 - $168 thousand; 2000 - $137 thousand; 
2001 - $135 thousand, 2002 - $101 thousand and $221 thousand thereafter.

During 1996, the Bank began a capital improvement project to upgrade its 
branch facilities and to make further investments in technology. At December 
31, 1997, approximately $6.9 million has been capitalized related to these 
projects and will be depreciated over the estimated useful lives of the 
individual assets once they are placed in service. Additionally, the Bank 
has retired assets with a total net book value of $1.2 million in 
conjunction with these projects. Losses realized on dispositions have been 
charged against current earnings, $596 thousand in 1997 and $602 thousand in 
1996.

During December 1997, a branch building and associated property located in 
Brattleboro, VT were transferred to the Other Real Estate Owned portfolio. 
The assets were valued at their fair market value of $450 thousand at the 
time of transfer which resulted in a $478 thousand charge to current 
earnings.

(5)   EMPLOYEE BENEFIT PLANS

Pension Plan

Prior to January 1995, the Company maintained a noncontributory defined 
benefit plan covering all eligible employees. The plan was a final average 
pay plan with benefits based on the average salary rates over the five 
consecutive plan years out of the last ten consecutive plan years that 
produce the highest average. It was the Company's policy to fund the cost of 
benefits expected to accrue during the year plus amortization of any 
unfunded accrued liability that had accumulated prior to the valuation date 
based on IRS regulations for funding. During 1994, the Company made the 
decision to freeze the plan beginning on January 1, 1995. During 1995, the 
plan was curtailed. Accordingly, all accrued benefits were fully vested and 
no additional years of service or age will be accrued. As a result of the 
curtailment, the Bank recognized a gain in the amount of $1.6 million in 
1995.

The plan's funded status and amounts recognized in the accompanying 
consolidated balance sheets and statements of operations as of December 31, 
1997 and 1996 are as follows:

<TABLE>
<CAPTION>
      (In thousands)                                    1997     1996
      -----------------------------------------------------------------
      <S>                                              <C>      <C>
      Projected Benefit Obligation for Service
       Rendered Through December 31, 1994              $6,610   $5,180
      Plan Assets                                       7,308    6,778
      -----------------------------------------------------------------
      Excess of Plan Assets Over
       Projected Benefit Obligation                       698    1,598
      Unrecognized Net Asset at January 1, 1987
       Being Amortized over 13.4 Years                    (54)     (99)
      Unrecognized Net Loss (Gain)                        602     (364)
      -----------------------------------------------------------------
      Prepaid Pension Costs Included
       In Other Assets                                 $1,246   $1,135
      =================================================================
</TABLE>

A summary of (income) expense relating to the Company's pension fund for 
each of the three years in the period ended December 31, 1997 is as follows:

<TABLE>
<CAPTION>
     (In thousands)                            1997      1996     1995
     ------------------------------------------------------------------
     <S>                                      <C>       <C>      <C>
     Interest Cost on Projected Benefit
      Obligation                              $ 452     $ 402    $ 394
     Actual Return on Plan Assets              (996)     (692)    (816)
     Net Amortization and Deferral              433       119      172
     ------------------------------------------------------------------
                                              $(111)    $(171)   $(250)
     ==================================================================
</TABLE>

The actuarial present value of the projected benefit obligation was 
determined using a weighted average discount rate of 7%, 7.6% and 7.5% as of 
December 31, 1997, 1996 and 1995, respectively. For 1997, 1996 and 1995 
there was no assumed rate of increase in future compensation due to the 
freeze on plan benefits. The expected long-term rate of return on assets 
used was 8% in 1997, 9% in 1996 and 8% in 1995.

Employee Stock Ownership Plan/401(k) Plan

Under the terms of the Company's Employee Stock Ownership Plan (ESOP), 
eligible employees are entitled to contribute up to 15% of their 
compensation to the ESOP, and the Company contributes a percentage of the 
amounts contributed by the employees, as authorized by the Company's Board 
of Directors. The Company contributed approximately 126% and 120%, 
respectively, of the amounts contributed by the employees (200% of up to 
4.5% of individual employee compensation in 1997 and 1996) in 1997 and 1996. 
Substantially all employer contributions to the ESOP are funded with cash 
and are used to purchase the Company's common stock.

Deferred Compensation Plans

Through December 1995, the Bank maintained an Executive Salary Continuation 
Plan and a Deferred Compensation Plan for Directors. In December 1995, the 
Bank and participants in its Executive Salary Continuation Plan and in the 
Fixed Growth Program of its Deferred Compensation Plan for Directors agreed 
to amend or terminate the existing plans. In satisfaction of all liabilities 
under those plans, the Bank agreed to make payments to, or credits for, the 
participants. Pursuant to these agreements, the Bank established several new 
plans (the "New Plans") and established certain trusts (the "Trusts") with 
Merchants Trust Company, to which it contributed an amount sufficient to 
cover the Bank's obligations under the New Plans. The New Plans used those 
payments, in part, to purchase newly issued common stock of the Company at 
its market price. The purchases have been accounted for as treasury stock 
transactions in the Company's consolidated financial statements. The 
portions of the payments made to the New Plans that were not invested in the 
common stock of the Company are included as investments in the consolidated 
financial statements and are classified as trading. In conjunction with the 
amendment and termination of the existing plans, the Bank either sold or 
surrendered certain life insurance policies and used the proceeds as a 
partial source to fund the lump sum payments made to the New Plans. As a 
result of these transactions, the Bank recognized increased earnings of $673 
thousand in 1995. To the extent the obligations of the Company under the New 
Plans are based on investments by the New Plans in other than shares of the 
Company, the investments will be revalued at each reporting date with a 
corresponding adjustment to compensation expense. In addition, the 
obligation related to certain Company shares, originally purchased for $200 
thousand, were revalued at each reporting date, with a corresponding 
adjustment to compensation expense. These Company shares were sold during 
December 1997.

Until July 1, 1997, Directors of the Bank were entitled to defer a portion 
of their compensation into a Deferred Compensation Plan for Directors known 
as the "Floating Growth (savings)" program. The Board of Directors voted at 
their February 1997 meeting to amend the Plan to provide that no additional 
compensation may be deferred into the Floating Growth (savings) program 
after July 1, 1997.  Benefits accrue based on a monthly allowance for 
interest at a rate that is fixed from time to time at the discretion of the 
Board of Directors. The benefits under the Floating Growth (savings) program 
of the Deferred Compensation Plan for Directors and the New Plans are 
generally payable starting on the January 2 following a participant's 65th 
birthday or earlier death, and will be distributed to the participant (or 
upon the participant's death, to the participant's designated beneficiary) 
in accordance with the Plan.

Phantom Stock Plan

The Company maintained a Phantom Stock Plan, wherein certain key officers of 
the Bank were entitled to receive an annual award of phantom shares of stock 
for up to five consecutive years. All such awards were granted by 
June 30, 1993. In December 1995, the Bank entered into agreements with 
certain participants in the Bank's Phantom Stock Plan. The Bank agreed to 
pay, and those participants agreed to accept, lump sum amounts in full 
satisfaction of the Bank's obligations under the Plan.

A summary of (income) expense relating to the Company's various employee 
benefit plans for each of the three years in the period ended December 31, 
1997 is as follows:

<TABLE>
<CAPTION>
      (In thousands)                       1997       1996       1995
      ----------------------------------------------------------------
      <S>                                 <C>        <C>        <C>
      Pension Plan                        $(150)     $(144)     $(250)
      Employee Stock Ownership
       Plan/401(k) Plan                     685        653        808
      Deferred Compensation Plans            20         27         25
      Phantom Stock Plan                      0        (16)        68
      ----------------------------------------------------------------
      Total                               $ 555      $ 520      $ 651
      ================================================================
</TABLE>

							  
(6)   STOCK BASED COMPENSATION PLANS

Stock Option Plans

The Company has granted stock options to certain key employees. The options 
granted vest after two years and are immediately exercisable upon vesting. 
Nonqualified stock options may be granted at any price determined by the 
Compensation Committee of the Board of Directors. All stock options have 
been granted at or above fair market value at the date of grant.


A summary of the Company's stock option activity is as follows

<TABLE>
<CAPTION>
                                    1997                1996               1995
-------------------------------------------------------------------------------------
                                       Weighted            Weighted            Option
                              Number   Average    Number   Average    Number   Price
                                Of     Exercise     Of     Exercise     of      Per
                              Shares    Price     Shares    Price     Shares   Share
-------------------------------------------------------------------------------------
                                   (In thousands except per share data)
<S>                             <C>     <C>         <C>     <C>         <C>    <C>
Options outstanding,
 beginning of year               50     $12.45      40      $11.72      20     $11.00
Granted                          71     $25.69      10      $15.38      20     $12.44
Exercised                        18      10.72      --          --      --         --
-------------------------------------------------------------------------------------
Options outstanding,
 end of year                    103     $21.88      50      $12.45      40     $11.72
Options exercisable              22     $12.53      20      $11.00      --         --
Weighted average fair value
 per option of options
 granted during year                    $ 6.71              $ 6.83             $ 6.72 
-------------------------------------------------------------------------------------
</TABLE>

As of December 31, 1997, the exercisable options outstanding were 
exercisable at prices ranging from $10.00 to $14.88 and had a weighted-
average remaining contractual life of 4.2 years.

In October, 1995 the FASB issued SFAS No. 123, "Accounting for Stock Based 
Compensation" ("SFAS No. 123") which establishes a fair value based method 
of recognizing stock-based compensation expense. As permitted by SFAS No. 
123, the Company has elected to continue to apply APB No. 25 to account for 
its stock-based compensation plans.  Had compensation cost for awards under 
the Company's stock-based compensation plans been determined consistent with 
the method set forth under SFAS No. 123, the effect on the Company's net 
income and earnings per share would have been as follows:

<TABLE>
<CAPTION>
                                          1997                        1996
------------------------------------------------------------------------------------
                                As Reported    Pro Forma    As Reported    Pro Forma
------------------------------------------------------------------------------------
                                        (In thousands except per share data)
<S>                                <C>           <C>           <C>           <C>
Net Income                         $8,833        $8,679        $6,224        $6,063
Basic Earnings per Share           $ 2.00        $ 1.97        $ 1.45        $ 1.41
Diluted Earnings per Share         $ 1.99        $ 1.96        $ 1.45        $ 1.41
------------------------------------------------------------------------------------
</TABLE>

Because the method prescribed by SFAS No. 123 has not been applied to 
options granted prior to January 1, 1995, the resulting pro forma 
compensation expense may not be representative of the amount to be expected 
in future years. Pro forma compensation expense for options granted is 
reflected over the vesting period; therefore, future pro forma compensation 
expense may be greater as additional options are granted.

The fair value of each option grant is estimated on the grant date using the 
Black-Scholes option-pricing model with the following weighted-average 
assumptions used for grants in 1997 and 1996, respectively: Risk-free 
interest rates of 6.00% for 1997 and 1996; Expected lives of options of 4 
years for 1997 and 1996; Expected volatility of stock of 34.37% and 31.40%; 
Rate of dividends of 2.48% and 2.08%; and Pro-forma after tax compensation 
expense of $308 thousand for 1997 and $161 thousand for 1996.

The Black-Scholes option-pricing model was developed for use in estimating 
the fair value of traded options that have no vesting restrictions and are 
fully transferable. In addition, option-pricing models require the input of 
highly subjective assumptions. Because the Company's employee stock options 
have characteristics significantly different from those of traded options, 
and because changes in the subjective input assumptions can materially 
affect the fair value estimate, in management's opinion, the existing models 
do not necessarily provide a reliable single measure of the fair value of 
its employee stock options.

Restricted Stock Plans

The Company and the Bank adopted new compensation plans for non-employee 
directors during 1997. Under the terms of the plans participating directors 
may elect to have all or a specified percentage of his or her compensation 
for a given year paid in the form of cash or deferred in the form of shares 
of restricted common stock of the Company. Directors who elect to have their 
compensation deferred shall be credited with a number of shares of the 
Company's stock equal in value to the amount of fees deferred plus a risk 
premium of not more than 25% of the amount deferred. The participating 
director may not generally sell, transfer or otherwise dispose of these 
shares, prior to the fifth anniversary of the date of the grant of such 
shares. With respect to shares of common stock issued or otherwise 
transferred to a participating director, the participating director will 
have the right to vote the shares and receive dividends or other 
distributions thereon. If a participating director resigns under certain 
circumstances the director shall forfeit all of his or her restricted shares 
which are risk premium shares. During 1997, 2,604 shares of common stock of 
the Company were distributed to a trust established under the terms of the 
new compensation plan. The "risk premium" is treated as an offset to 
stockholder's equity labeled "Unearned Compensation" and will be recognized 
as an expense ratably over the five-year restriction period.

(7)   INCOME TAXES

The provision (benefit) for income taxes for each of the three years in the 
period ended December 31, 1997 consists of the following:

<TABLE>
<CAPTION>
        (In thousands)             1997       1996        1995
        --------------------------------------------------------
        <S>                       <C>       <C>         <C>
        Current                   $1,499    $ 3,307     $(3,092)
        Deferred (Prepaid)           884     (1,475)       (693)
        --------------------------------------------------------
                                  $2,383    $ 1,832     $(3,785)
        ========================================================
</TABLE>

Prepaid and deferred income taxes result from differences between the income 
(loss) for financial reporting and tax reporting relating primarily to the 
provision for possible loan losses. The net deferred tax asset amounted to 
approximately $4.4 million and $5.4 million at December 31, 1997 and 1996, 
respectively. This tax asset is included in other assets in the accompanying 
consolidated balance sheets.

The components of the net deferred tax asset as of December 31, 1997 and 
1996 are as follows:

<TABLE>
<CAPTION>
      (In thousands)                                1997        1996
      ----------------------------------------------------------------
      <S>                                         <C>         <C>
      Reserve for Possible Loan Losses            $ 5,605     $ 6,261
      Deferred Compensation                         1,335       1,278
      Unrealized Securities Gains                    (197)       (129)
      Loan Fees                                       191         191
      Depreciation                                   (599)       (481)
      Accrued Liabilities                            (335)        291
      Capital Loss Carryforwards                      618         937
      Investments in Limited Partnerships            (712)       (668)
      Excess Servicing Right                          (31)        (43)
      Loan Market Adjustment                       (4,505)     (3,368)
      Other                                        (1,131)     (1,526)
      Tax Credit Carryforwards                      4,293       3,150
      Core Deposit Intangible                         526         434
      ----------------------------------------------------------------
                                                    5,058       6,327
      Valuation Allowance                            (618)       (937)
      ----------------------------------------------------------------
                                                  $ 4,440     $ 5,390
      ================================================================
</TABLE>

A valuation allowance is provided when it is more likely than not that some 
portion of the net prepaid tax asset will not be realized. The Company has 
established a valuation allowance for capital loss carryforwards since such 
losses may only be utilized against future capital gains.

The following is a reconciliation of the federal income tax provision 
(benefit), calculated at the statutory rate, to the recorded provision 
(benefit) for income taxes:

<TABLE>
<CAPTION>
(In thousands)                                    1997      1996        1995
------------------------------------------------------------------------------
<S>                                             <C>        <C>        <C>
Applicable Statutory Federal Income
 Tax (Benefit)                                  $ 3,779    $2,739     $(2,593)
(Reduction) Increase in Taxes		  
 Resulting From:            
  Gain / (Loss) on Investment Securities           (134)       27        (114)
  Tax-exempt Income                                 (55)      (74)        (87)
  Tax Credits                                    (1,089)     (980)       (851)
  Other, Net                                       (118)       46        (227)
------------------------------------------------------------------------------
                                                $ 2,383    $1,832     $(3,785)
==============================================================================
</TABLE>

The state of Vermont assesses a franchise tax for banks in lieu of income 
tax. The franchise tax is assessed based on deposits and amounted to 
approximately $386 thousand, $255 thousand, and $277 thousand in 1997, 1996, 
and 1995, respectively. These amounts are included in other expenses in the 
accompanying consolidated statements of operations. The Company received 
refunds of its 1995, 1994, and 1993 Vermont Franchise Taxes of $272 
thousand, $285 thousand, and $240 thousand, respectively, during 1996.

(8)   OTHER BORROWED FUNDS

Other borrowed funds consist of the following at December 31, 1997 and 1996:

<TABLE>
<CAPTION>
          (In thousands)                          1997      1996
          -------------------------------------------------------
          <S>                                    <C>       <C>
          Treasury Tax and Loan Notes            $4,000    $3,599
          Short Term Borrowing                    4,000     6,000
          -------------------------------------------------------
                                                 $8,000    $9,599
          =======================================================
</TABLE>

As of December 31, 1997, the Bank may borrow up to $20 million in federal 
funds on an unsecured basis. 

The following table provides certain information regarding other borrowed 
funds for the two years ended December 31, 1997 and 1996:

<TABLE>
<CAPTION>
                                  Maximum                      Weighted
                                 Month-End       Average     Average Rate      Weighted
                                  Amount         Amount         During       Average Rate
(In thousands)                  Outstanding    Outstanding     the Year       at Year End
-----------------------------------------------------------------------------------------
<S>                               <C>             <C>            <C>             <C>
1997                
Treasury Tax and Loan Notes       $ 4,182         $2,413         5.39%           5.27%
Federal Funds Purchased             3,850            906         5.99              --
Short Term Borrowing               15,000          4,880         5.87            6.16
-----------------------------------------------------------------------------------------
1996                
Treasury Tax and Loan Notes       $ 4,572         $2,134         5.06%           5.37%
Federal Funds Purchased            11,500            703         4.59              --
Short Term Borrowing               11,500            774         5.46            5.90
Repurchase Agreements               7,660          2,366         5.79            4.48
-----------------------------------------------------------------------------------------
</TABLE>

(9)   DEBT

Debt consists of the following at December 31, 1997 and 1996:

<TABLE>
<CAPTION>
(In thousands)                                                 1997       1996
-------------------------------------------------------------------------------
<S>                                                           <C>        <C>
9% Mortgage Note, Payable in Monthly Installments of
 $1.7 thousand (Principal and Interest) Through 2020          $  200     $  203
8.75% Mortgage Note, payable in Monthly Installments of
 $2.5 thousand (Principal and Interest) Through 2039           1,185      1,187
Federal Home Loan Bank Notes Payable, Interest Rates
 From 7.52% to 8.66% Due in 2001                               5,030      5,030
-------------------------------------------------------------------------------
                                                              $6,415     $6,420
===============================================================================
</TABLE>

The 8.75% mortgage note relates to a low-income housing project. The monthly 
installments are subsidized by the U.S. Department of Agriculture, which 
pays $76 thousand annually so as to reduce the monthly principal and 
interest payments to an amount equivalent to a loan at a basis rate of 1%.

Maturities of debt subsequent to December 31, 1997 are as follows: 1998--$6 
thousand; 1999--$6 thousand; 2000--$7 thousand; 2001--$5,038 thousand; 2002--$8 
thousand and $1,350 thousand thereafter.

As of December 31, 1997, the Company is in compliance with all of the 
covenants of the Federal Home Loan Bank ("FHLB") agreements.

(10)  STOCKHOLDERS' EQUITY

Vermont state law requires the Bank to appropriate a minimum of 10% of net 
income to surplus until such time as appropriated amounts equal 10% of 
deposits and other liabilities. The Company's stockholders' equity includes 
$8.1 million as of December 31, 1997 and $7.2 million as of December 31, 
1996 of such appropriations. Vermont state law also restricts the payment of 
dividends under certain circumstances.

(11)  EARNINGS PER SHARE

The following table presents a reconciliation of the calculations of basic 
and diluted earnings per share for the year ended December 31, 1997:

<TABLE>
<CAPTION>
                                                                                  Per Share
                                                Income           Shares            Amount
---------------------------------------------------------------------------------------------
                                               (In thousands except share and per share data)
<S>                                            <C>             <C>                  <C>
Basic Earnings Per Share:            
  Income Available to Common Shareholders      $8,833          4,423,153            $2.00
Diluted Earnings Per Share:            
  Options issued to Executives (See Note 6)        --             23,256    
  Income Available to Common Shareholders
   plus Assumed Conversions                    $8,833          4,446,409            $1.99
=============================================================================================
</TABLE>

Basic earnings per common share were computed by dividing net income by the 
weighted average number of shares of common stock outstanding during the 
year. Upon adoption of SFAS No. 128 the Company's reported earnings per 
share for 1996 and 1995 were restated. There was no effect on earnings per 
share for prior periods.

(12)  REENGINEERING

The Company began a reengineering project during 1995 to reduce ongoing 
operating costs. As a result, the Bank implemented a plan to reduce its 
workforce by approximately 250 employees. All employees were offered the 
opportunity to voluntarily terminate their employment, which would entitle 
them to a severance package equal to one week's pay for each year of service 
plus four additional weeks. Employees whose age plus years of service with 
the Company equalled at least 60 were offered an early retirement option 
whereby, in lieu of the plan described above, five years would be added to 
both their years of service and their age for purposes of determining vested 
benefits through the pension plan. The total severance charges incurred by 
the Company as a result of the reengineering project were approximately $1.3 
million. The incremental cost of the enhanced early retirement benefit 
realized during 1995 was approximately $728 thousand.

In conjunction with the reengineering project, the Company engaged a 
consulting firm to assist in the identification of possible workforce 
reductions and the implementation of the reengineering plan. The fee earned 
by these consultants was, in part, contingent upon actual future operating 
cost reductions and the increase in noninterest income. The Company 
recognized all expenses associated with fees to these consultants of 
approximately $2 million in 1995. Pursuant to an agreement with these 
consultants, the Company made final payment to the consultants in 1997.

(13)  COMMITMENTS AND CONTINGENCIES

The Bank is a counterclaim defendant in a litigation entitled Pasquale and 
Vatsala Vescio, Counterclaim Plaintiffs v. The Merchants Bank, Counterclaim 
Defendant, now pending in the United States Bankruptcy Court for the 
District of Vermont.

In this litigation, the Vescios have made a number of "lender liability" 
claims dealing with a commercial development known as Brattleboro West in 
Brattleboro, Vermont. The pending litigation arose out of a suit to 
foreclose on several real estate mortgages and personal property originally 
granted to the Bank by the Vescios in connection with the financing of a 
supermarket in the Brattleboro West project and various other projects.

Among other things, the Vescios have alleged that the Bank or its 
representatives violated supposed oral promises in connection with the 
origination and funding of the financing, and have claimed that the Bank is 
liable to them for damages based on the Bank's supposed "control" of the 
project and its alleged breach of covenants of "good faith" which the 
plaintiffs believe are to be implied from the loan documents. In addition, 
the plaintiffs have contended that the Bank breached some kind of duty of 
care they believe it owed to them, and have claimed that the Bank should not 
have exercised its contract rights when the loan went into default, but 
should have worked out the default in a way that was more favorable to the 
borrowers. The parties have conducted extensive discovery and the matter is 
now being tried in the Bankruptcy Court for the District of Vermont. 
Although it is not possible at this stage to predict the outcome of this 
litigation, the Bank believes that it has meritorious defenses to the 
plaintiffs' allegations. The Bank intends to vigorously defend itself 
against these claims.

The Company, the Bank, the Trust Company (the "Companies") and certain of 
their directors are defendants in a lawsuit filed in November of 1994 (the 
"Vermont Proceedings"). The Vermont Proceedings arose from certain 
investments managed for Trust Company customers and placed into the Piper 
Jaffray Institutional Government Income Portfolio (the "Portfolio"). In 
December of 1994, the Companies made payments to the Trust Company customers 
in amounts that the Companies believe reimbursed those customers fully for 
Portfolio losses. The United States District Court for the District of 
Vermont has dismissed the Plaintiff's claims in the Vermont Proceedings with 
prejudice, as moot, and has ordered payment of approximately $99,000 in 
attorneys fees to the attorneys representing the Plaintiff. The Plaintiff 
and his attorneys have appealed to the Second Circuit Court of Appeals the 
District Court's orders, and the Companies have appealed on certain limited 
issues.

The Companies have separately pursued claims against others on account of 
the losses suffered as a result of the investments in the Portfolio. Claims 
against Piper Jaffray Companies, Inc. were joined with the claims of others 
in a class action in the United States District Court for the District of 
Minnesota (the "Minnesota Proceedings"). The Minnesota Proceedings were 
settled by the parties and in February of 1997 the District Court ordered 
the net share of the settlement proceeds attributable to the Trust Company's 
investments to be paid to the Trust Company, starting approximately sixty 
days after the Court's order becomes final, except to the extent, if at all, 
any other court with jurisdiction has sooner given leave for some or all of 
those payments to be deposited with such other court pursuant to applicable 
rules. The attorneys representing the Plaintiff in the Vermont Proceedings 
and also representing, in the Minnesota Proceedings, the beneficiaries of 
four other Trust Company accounts, have appealed that order to the Eighth 
Circuit Court of Appeals. Those attorneys have taken the position that 
notwithstanding the payments made by the Companies to the Trust Company 
customers in December of 1994, any amounts paid under the Minnesota 
Proceedings on account of the Trust Company's Portfolio investments should 
be paid directly to the affected Trust Company customers (net of legal fees 
to be paid to those attorneys). Any recovery by the Companies from the 
Minnesota Proceedings is subject to the terms of an agreement between the 
Companies and their insurance carrier, which reimbursed the Companies, in 
part, for the December, 1994 payments.

Merchants Bancshares, Inc. and certain of its subsidiaries have been named 
as defendants in various legal proceedings arising from their normal 
business activities. Although the amount of any ultimate liability with 
respect to such proceedings cannot be determined, in the opinion of 
management, based upon the opinion of counsel on the outcome of such 
proceedings, any such liability will not have a material effect on the 
consolidated financial position of Merchants Bancshares, Inc. and its 
subsidiaries.

(14)  PARENT COMPANY

The Parent Company's investments in its subsidiaries are recorded using the 
equity method of accounting. Summarized financial information relative to 
the Parent Company only balance sheets at December 31, 1997 and 1996 and 
statements of operations and cashflows for each of the three years in the 
period ended December 31, 1997 are as follows:

<TABLE>
<CAPTION>
(In thousands)        
Balance Sheets as of December 31,                          1997      1996
----------------------------------------------------------------------------
<S>                                                       <C>        <C>
Assets:        
  Investment in and Advances to Subsidiaries*             $54,703    $47,999
  Other Assets                                              1,337        860
----------------------------------------------------------------------------
    Total Assets                                          $56,040    $48,859
============================================================================
Liabilities and Equity Capital:        
  Other Liabilities                                       $ 3,104    $ 2,610
  Equity Capital                                           52,936     46,250
----------------------------------------------------------------------------
    Total Liabilities and Equity Capital                  $56,040    $48,860
============================================================================

<CAPTION>
(In thousands)            
Statements of Operations for the Years Ended December 31,     1997      1996        1995
------------------------------------------------------------------------------------------
<S>                                                          <C>       <C>        <C>
Dividends from Merchants Bank*                               $2,267    $   --     $    --
Equity in Undistributed Earnings (Losses) of Subsidiaries     6,652     6,306      (4,021)
Other Income (Expense), Net                                    (130)     (125)         72
(Provision) Benefit from Income Taxes                           (44)       43         107
------------------------------------------------------------------------------------------
Net Income (Loss)                                            $8,833    $6,224     $(3,842)
==========================================================================================

<F*>   Account balances are partially or fully eliminated in consolidation.
</TABLE>

<TABLE>
<CAPTION>
(In thousands)            
Statements of Cash Flows for the Years Ended December 31,    1997       1996        1995
------------------------------------------------------------------------------------------
<S>                                                         <C>        <C>        <C>
Cash Flows from Operating Activities:            
  Net Income (Loss)                                         $8,833     $6,224     $(3,842)
  Adjustments to Reconcile Net Income (Loss) to Net Cash
   Provided by Operating Activities:            			    
    Gains on Investment Securities                              --         --        (309)
    (Increase) Decrease in Miscellaneous Receivables           116         99        (613)
    Increase in Miscellaneous Payables                          40         --       2,528
    Equity in Undistributed (Income)            
      Losses of Subsidiaries                                (6,679)    (6,306)      4,021
------------------------------------------------------------------------------------------
Net Cash Provided by Operating Activities                    2,310         17       1,785
------------------------------------------------------------------------------------------
            
Cash Flows from Investing Activities:            
  Repayment of Advances from Subsidiaries                       --         --       1,035
  Proceeds from Sales of Investment Securities                  --         --         644
------------------------------------------------------------------------------------------
Net Cash Provided by Investing Activities                       --         --       1,679
------------------------------------------------------------------------------------------
            
Cash Flows From Financing Activities:            
  Sale of Treasury Stock                                     1,234         --         179
  Acquisition of Treasury Stock                             (1,390)        --      (2,083)
  Proceeds from Exercise of Employee Stock Options              42         --          --
  Issuance of Common Stock                                      --         --       2,554
  Principal Payments on Debt                                    --         --      (4,800)
  Dividends Paid                                            (2,217)        --          --
  Other, Net                                                   (35)        --          --
------------------------------------------------------------------------------------------
Net Cash Used in Financing Activities                       (2,366)        --      (4,150)
------------------------------------------------------------------------------------------
            
Increase (decrease) in Cash and Cash Equivalents               (56)        17        (686)
Cash and Cash Equivalents at Beginning of Year                 318        301         987
------------------------------------------------------------------------------------------
Cash and Cash Equivalents at End of Year                    $  262     $  318     $   301
==========================================================================================
Total Interest Payments                                     $   --     $   --     $   333
Taxes Paid                                                   3,820         --          --
------------------------------------------------------------------------------------------
</TABLE>

(15)  FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK 

Commitments and Off-Balance Sheet Risk

The Bank is a party to financial instruments with off-balance sheet risk in 
the normal course of business to meet the financing needs of its customers. 
These financial instruments primarily include commitments to extend credit 
and financial guarantees. Such instruments involve, to varying degrees, 
elements of credit and interest rate risk that are not recognized in the 
accompanying consolidated balance sheets.

Exposure to credit loss in the event of nonperformance by the other party to 
the financial instruments for commitments to extend credit and financial 
guarantees written is represented by the contractual amount of those 
instruments. The Bank uses the same credit policies in making commitments as 
it does for on-balance sheet instruments. The contractual amounts of these 
financial instruments at December 31, 1997 and 1996 are as follows:

<TABLE>
<CAPTION>
    (In thousands)                                   Contractual Amount
    -------------------------------------------------------------------
    <S>                                                    <C>
    1997    
    Financial Instruments Whose Contract Amounts
     Represent Credit Risk:    
      Commitments to Extend Credit                         $81,762
      Standby Letters of Credit                              5,650
      Loans Sold with Recourse                               1,182
    -------------------------------------------------------------------
<CAPTION>
    (In thousands)                                   Contractual Amount
    -------------------------------------------------------------------
    <S>                                                    <C>
    1996    
    Financial Instruments Whose Contract Amounts
     Represent Credit Risk:    
      Commitments to Extend Credit                         $80,756
      Standby Letters of Credit                              6,104
      Loans Sold with Recourse                               1,219
    -------------------------------------------------------------------
</TABLE>

Commitments to extend credit are agreements to lend to a customer as long as 
there is no violation of any condition established in the contract. 
Commitments generally have fixed expiration dates or other termination 
clauses and may require payment of a fee. Since a portion of the commitments 
are expected to expire without being drawn upon, the total commitment amount 
does not necessarily represent a future cash requirement. The Bank evaluates 
each customer's creditworthiness on a case-by-case basis. The amount of 
collateral obtained by the Bank upon extension of credit is based on 
management's credit evaluation of the counterparty, and an appropriate 
amount of real and/or personal property is obtained as collateral.

Standby letters of credit and financial guarantees written are conditional 
commitments issued by the Bank to guarantee performance of a customer to a 
third party. Those guarantees are primarily issued to support public and 
private borrowing arrangements. Most guarantees extend for less than two 
years, and approximately 75% are for less than $100 thousand. The credit 
risk involved in issuing letters of credit is essentially the same as that 
involved in extending loan facilities to customers. The Bank obtains real 
and/or personal property as collateral for those commitments for which 
collateral is deemed to be necessary.

The Bank may enter into commitments to sell loans, which involve market and 
interest rate risk. There were no such commitments at December 31, 1997 or 
1996.

Interest Rate Floor Contracts

Interest rate floor transactions generally involve the exchange of fixed and 
floating rate interest payments without the exchange of the underlying 
principal amounts. The Company uses floor contracts to mitigate the effects 
on net interest income in the event interest rates on floating rate loans 
decline. The Company is exposed to risk should the counterparty default in 
its responsibility to pay interest under the terms of the floor agreement, 
but minimizes this risk by performing normal credit reviews on the 
counterparties, by limiting its exposure to any one counterparty, and by 
utilizing well known national investment firms as counterparties. Notional 
principal amounts are a measure of the volume of agreements transacted, but 
the level of credit risk is significantly less. At December 31, 1997 and 
December 31, 1996, the notional principal amounts of such contracts 
outstanding was $30 million and $20 million respectively. At December 31, 
1997 and December 31, 1996, the amortized cost of such contracts was $69 
thousand and $74 thousand respectively. No amounts have been received with 
respect to these contracts.

(16)  FAIR VALUE OF FINANCIAL INSTRUMENTS

Investments

The carrying amounts reported in the consolidated balance sheets for cash 
and cash equivalents and stock in the Federal Home Loan Bank of Boston 
approximate fair values. Fair value for investment securities is determined 
from quoted market prices, when available. If quoted market prices are not 
available, fair values are based on quoted market prices of comparable 
instruments. 

An analysis of the fair value of the investment securities as of December 
31, 1997 and 1996 is as follows:

<TABLE>
<CAPTION>
                                           1997                      1996
----------------------------------------------------------------------------------
                                  Carrying                  Carrying    
(In thousands)                     Amount     Fair Value     Amount     Fair Value
----------------------------------------------------------------------------------
<S>                               <C>          <C>          <C>          <C>
Securities Available for Sale     $ 44,241     $ 44,241     $ 57,656     $ 57,656
Securities Held to Maturity        111,458      112,467       86,904       86,004
Marketable Equity Securities            --           --          230          230
----------------------------------------------------------------------------------
                                  $155,699     $156,708     $144,790     $143,890
==================================================================================
</TABLE>

Loans

The fair value of variable rate loans that reprice frequently and have no 
significant credit risk is based on carrying values. The fair value of fixed 
rate (one-to-four family residential) mortgage loans, and other consumer 
loans, is based on quoted market prices of similar loans sold in conjunction 
with securitization transactions, adjusted for differences in loan 
characteristics. The fair value for other loans is estimated using 
discounted cash flow analyses, using interest rates currently being offered 
for loans with similar terms to borrowers of similar credit quality. 

An analysis of the fair value of the loan portfolio as of December 31, 1997 
and 1996 is as follows:

<TABLE>
<CAPTION>
                                           1997                      1996
----------------------------------------------------------------------------------
                                  Carrying                  Carrying    
(In thousands)                     Amount     Fair Value     Amount     Fair Value
----------------------------------------------------------------------------------
<S>                               <C>          <C>          <C>          <C>
Net Loans                         $374,557     $378,093     $371,533     $371,187
----------------------------------------------------------------------------------
</TABLE>

Deposits

The fair value of demand deposits approximates the amount reported in the 
consolidated balance sheets. The fair value of variable rate, fixed term 
certificates of deposit also approximate the carrying amount reported in the 
consolidated balance sheets. The fair value of fixed rate and fixed term 
certificates of deposit is estimated using a discounted cash flow which 
applies interest rates currently being offered for deposits of similar 
remaining maturities.

An analysis of the fair value of deposits as of December 31, 1997 and 1996 
is as follows:

<TABLE>
<CAPTION>
                                           1997                      1996
----------------------------------------------------------------------------------
                                  Carrying                  Carrying    
(In thousands)                     Amount     Fair Value     Amount     Fair Value
----------------------------------------------------------------------------------
<S>                               <C>          <C>          <C>          <C>
Demand Deposits                   $ 76,712     $ 76,712     $ 80,576     $ 80,576
Savings, NOW and Money Market      267,396    	268,380      263,882      263,967
Time Deposits $100 thousand
 and greater                        23,307       23,540       20,370       20,522
Other Time Deposits                138,429      139,812      143,452      144,516
----------------------------------------------------------------------------------
                                  $505,844     $508,444     $508,280     $509,581
==================================================================================
</TABLE>

Debt

The fair value of debt is estimated using current market rates for 
borrowings of similar remaining maturity.

An analysis of the fair value of the borrowings of the Company as of 
December 31, 1997 and 1996 is as follows:

<TABLE>
<CAPTION>
                                      1997                      1996
-----------------------------------------------------------------------------
                             Carrying                  Carrying     
(In thousands)                Amount     Fair Value     Amount     Fair Value
-----------------------------------------------------------------------------
<S>                           <C>          <C>          <C>          <C>
Other Borrowed Funds          $8,000       $8,000       $9,599       $9,599
-----------------------------------------------------------------------------
Debt                           6,415        6,645        6,420        6,732
-----------------------------------------------------------------------------
</TABLE>

Commitments to Extend Credit And Standby Letters Of Credit

The fair value of commitments to extend credit is estimated using the fees 
currently charged to enter into similar agreements, taking into account the 
remaining terms of the agreements and the present creditworthiness of the 
counterparties. For fixed rate loan commitments, fair value also considers 
the difference between current levels of interest rates and the committed 
rates. The fair value of financial standby letters of credit is based on 
fees currently charged for similar agreements or on the estimated cost to 
terminate them or otherwise settle the obligations with the counterparties. 
The fair value of commitments to extend credit and standby letters of credit 
is $65 thousand and $88 thousand as of December 31, 1997 and 1996, 
respectively.

Interest Rate Floors

The fair value of the interest rate floors associated with variable rate 
commercial loans approximates the book carrying value. Management bases 
estimates on quotes, from qualified investment brokers, of the market value 
of the floor at the reporting date. The fair value of the interest rate 
floor contracts at December 31, 1997 was $49 thousand, the amortized cost 
was $69 thousand.


(17)  SUMMARY OF UNAUDITED FINANCIAL INFORMATION:

<TABLE>
<CAPTION>
(In thousands except per share data)        1997                                                   1996        
-------------------------------------------------------------------------------------------------------------------------------
                       Q4         Q3         Q2         Q1         Year       Q4         Q3         Q2         Q1         Year
-------------------------------------------------------------------------------------------------------------------------------
<S>                  <C>        <C>        <C>        <C>        <C>        <C>        <C>        <C>        <C>        <C>
Interest and Fee                                        
 Income              $12,120    $12,137    $12,017    $11,884    $48,158    $11,909    $11,901    $11,990    $12,204    $48,004
Interest Expense       4,616      4,578      4,576      4,468     18,238      4,599      4,573      4,642      4,858     18,672
-------------------------------------------------------------------------------------------------------------------------------
Net Interest                                        
 Income                7,504      7,559      7,441      7,416     29,920      7,310      7,328      7,348      7,346     29,332
Provision for                                        	
 Possible Loan                                        
 Losses(1)            (2,162)        --         --        300     (1,862)       450        900        900        900      3,150
Noninterest                                        
 Income(2)             2,700      1,740      1,715      1,761      7,916      1,972      1,897      2,174      2,913      8,956
Noninterest                                        
 Expense(3)            9,057      6,445      6,468      6,512     28,482      6,582      6,215      6,639      7,646     27,082
-------------------------------------------------------------------------------------------------------------------------------
Income Before                                        	
 Provision for                                        
 Income Taxes          3,309      2,854      2,688      2,365     11,216      2,250      2,110      1,983      1,713      8,056
Provision For                                        
 Income Taxes            607        665        610        501      2,383        548        501        439        344      1,832
-------------------------------------------------------------------------------------------------------------------------------
Net Income           $ 2,702    $ 2,189    $ 2,078    $ 1,864    $ 8,833    $ 1,702    $ 1,609    $ 1,544    $ 1,369    $ 6,224
===============================================================================================================================
Basic Earnings                                        
 Per Share           $  0.61    $  0.50    $  0.47    $  0.42    $  2.00    $  0.40    $  0.37    $  0.36    $  0.32    $  1.45
===============================================================================================================================
Cash Dividends                                        
 Declared Per                                        
 Share               $  0.15    $  0.15    $  0.10    $  0.10    $  0.50    $    --    $    --    $    --    $    --    $    --
===============================================================================================================================

<F1> During the fourth quarter of 1997 the Bank recognized recoveries on 
     two previously charged off loans of $2.2 million. This amount was credited
     to income through the provision for loan losses.
<F2> During the fourth quarter of 1997 the Bank recognized a gain of $840 
     on a security it held with a zero basis.
<F3> During the fourth quarter of 1997 the Bank recognized losses 
     resulting from its conversion to the Windows NT platform totaling $590 
     thousand; the Bank incurred or accrued legal and professional expenses in 
     conjunction with a lawsuit brought by a former customer totaling $1.2 
     million; the Bank made a one-time contribution to the Merchants Bank 
     Foundation of $400 thousand; and a $478 thousand write-down was taken 
     against one of the Bank's branch properties, based on the decision to sell 
     the property.
</TABLE>

(18)  REGULATORY ENVIRONMENT

The Bank and the Company are subject to various regulatory capital 
requirements administered by federal banking agencies. Failure to meet 
minimum capital requirements can initiate certain mandatory, and possible 
additional discretionary, actions by regulators that, if undertaken, could 
have a direct material effect on the Bank's and the Company's financial 
statements. Under capital adequacy guidelines, the Bank and the Company must 
meet specific capital guidelines that involve quantitative measures of the 
Bank's and the Company's assets, liabilities, and certain off-balance-sheet 
items as calculated under regulatory accounting practices. The Bank is also 
subject to the regulatory framework for prompt corrective action that 
requires the Bank to meet specific capital guidelines to be considered well 
capitalized. The Bank's and the Company's capital amounts and classification 
are also subject to qualitative judgments by the regulators about 
components, risk weightings and other factors.

Quantitative measures established by regulation to ensure capital adequacy 
require the Bank and the Company to maintain minimum ratios (set forth in 
the table below) of total and Tier-1 capital (as defined in the regulations) 
to risk-weighted assets (as defined) and of Tier-1 capital (as defined) to 
average assets (as defined). Management believes, as of December 31, 1997, 
that the Bank and the Company meet all capital adequacy requirements to 
which it is subject.

As of December 31, 1997, the most recent notification from the FDIC 
categorized the Bank as well-capitalized under the regulatory framework for 
prompt corrective action. There are no conditions or events since that 
notification that management believes have changed the institution's 
category. To be considered well capitalized under the regulatory framework 
for prompt corrective action, the Bank must maintain minimum Tier-1 
Leverage, Tier-1 Risk-Based, and Total Risk-Based Capital ratios as set 
forth in the table below.

<TABLE>
<CAPTION>
                                                                            To Be Well-
                                                                         Capitalized Under
                                                       For Capital       Prompt Corrective
(In thousands)                       Actual         Adequacy Purposes    Action Provisions
------------------------------------------------------------------------------------------
                               Amount    Percent    Amount    Percent    Amount    Percent
------------------------------------------------------------------------------------------
As of December 31, 1997:                        
                        
<S>                            <C>        <C>       <C>         <C>      <C>        <C>
Merchants Bancshares, Inc.:                        
  Tier 1 Risk-Based Capital    $50,596    12.49%    $16,201     4.00%        N/A    
  Total Risk-Based Capital      55,806    13.78      32,401     8.00         N/A    
  Tier 1 Leverage Capital       50,596     8.70      23,266     4.00         N/A    
Merchants Bank:                        
  Tier 1 Risk-Based Capital    $52,536    12.94%    $16,246     4.00%    $24,369    6.00%
  Total Risk-Based Capital      57,746    14.22      32,491     8.00      40,614   10.00
  Tier 1 Leverage Capital       52,536     9.01      23,313     4.00      29,141    5.00
------------------------------------------------------------------------------------------
As of December 31, 1996:                        
                        
Merchants Bancshares, Inc.:                        
  Tier 1 Risk-Based Capital    $43,814    11.08%    $15,811     4.00%        N/A    
  Total Risk-Based Capital      48,888    12.37      31,623     8.00         N/A    
  Tier 1 Leverage Capital       43,814     7.50      23,381     4.00         N/A    
Merchants Bank:                        
  Tier 1 Risk-Based Capital    $45,517    11.56%    $15,757     4.00%    $23,635    6.00%
  Total Risk-Based Capital      50,574    12.84      31,513     8.00      39,392   10.00
  Tier 1 Leverage Capital       45,517     7.80      23,330     4.00      29,163    5.00
------------------------------------------------------------------------------------------
</TABLE>


                 Merchants Bancshares, Inc. and Subsidiaries
                        Interest Management Analysis

<TABLE>
<CAPTION>
(In thousands, taxable equivalent)               1997                  1996                  1995
--------------------------------------------------------------------------------------------------------
                                          Interest    % of      Interest    % of      Interest    % of
                                          Income/    Average    Income/    Average    Income/    Average
                                          Expense     Assets    Expense     Assets    Expense     Assets
--------------------------------------------------------------------------------------------------------

<S>                                       <C>         <C>       <C>         <C>       <C>         <C>
NET INTEREST INCOME:
  Total Interest Income, Including
   Fees on Loans                          $ 48,254     8.35%    $ 48,140    8.29%     $ 51,315     7.99%
  Interest Expense                          18,238     3.15       18,672    3.21        23,002     3.58
--------------------------------------------------------------------------------------------------------
  Net Interest Income Before Provision
   for Possible Loan Losses                 30,016     5.19       29,468    5.07        28,313     4.41
  Provision for Possible Loan Losses        (1,862)   -0.32        3,150    0.54        12,100     1.88
--------------------------------------------------------------------------------------------------------
  Net Interest Income                     $ 31,878     5.51%    $ 26,318    4.53%     $ 16,213     2.52%
========================================================================================================

OPERATING EXPENSE ANALYSIS:
  Noninterest Expense
    Personnel                             $ 10,674     1.85%    $ 10,013    1.72%     $ 13,434     2.09%
    Occupancy Expense                        2,171     0.38        2,054    0.35         2,178     0.34
    Equipment Expense                        2,325     0.40        2,024    0.35         2,069     0.32
    Loss/(Gain) on Disposition of Fixed
     Assets                                  1,088     0.19         (565)                    0
    Other                                   12,224     2.11       13,556    2.33        15,974     2.49
--------------------------------------------------------------------------------------------------------
  Total Noninterest Expense                 28,482     4.93       27,082    4.66        33,655     5.24
--------------------------------------------------------------------------------------------------------
  Less Noninterest Income
    Service Charges on Deposits              3,075     0.53        3,347    0.58         3,184     0.50
    Other, Including Securities Gains        4,841     0.84        5,609    0.96         6,632     1.03
--------------------------------------------------------------------------------------------------------
  Total Noninterest Income                   7,916     1.37        8,956    1.54         9,816     1.53
--------------------------------------------------------------------------------------------------------
  Net Operating Expense                   $ 20,566     3.56%    $ 18,126    3.13%     $ 23,839     3.71%
========================================================================================================

SUMMARY:
  Net Interest Income                     $ 31,878     5.51%    $ 26,318    4.53%     $ 16,213     2.52%
    Less: Net Overhead                      20,566     3.56       18,126    3.13        23,839     3.71
--------------------------------------------------------------------------------------------------------
  Profit Before Taxes-
   Taxable Equivalent Basis                 11,312     1.96        8,192    1.41        (7,626)   -1.19
  Net Profit (Loss) After Taxes           $  8,833     1.53%    $  6,224    1.07%     $ (3,842)   -0.60%
--------------------------------------------------------------------------------------------------------
TOTAL AVERAGE ASSETS:                     $578,090              $580,860              $642,487
========================================================================================================
</TABLE>


                         Merchants Bancshares, Inc.
                       Five Year Summary of Operations
          (Not Covered by Report of Independent Public Accountants)

<TABLE>
<CAPTION>
                                                                    For the Years Ended December 31,
------------------------------------------------------------------------------------------------------------------
(In thousands except per share data)                     1997          1996        1995        1994        1993
------------------------------------------------------------------------------------------------------------------

<S>                                                    <C>           <C>         <C>         <C>         <C>
INCOME STATEMENT
Interest and Investment Income                         $ 48,158      $ 48,004    $ 51,315    $ 53,319    $ 51,474
Interest Expense                                         18,238        18,672      23,002      22,377      21,956
------------------------------------------------------------------------------------------------------------------
Net Interest Income                                      29,920        29,332      28,313      30,942      29,518
Provision for Possible Loan Losses                       (1,862)        3,150      12,100      10,000      23,822
------------------------------------------------------------------------------------------------------------------
Net Interest Income after Provision for Loan Losses      31,782        26,182      16,213      20,942       5,696
------------------------------------------------------------------------------------------------------------------
Other Income                                              7,916         9,363      12,766      15,038      12,128
Other Expense                                            28,482        27,489      36,606      41,712      28,016
------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) BEFORE INCOME TAXES                        11,216         8,056      (7,627)     (5,732)    (10,192)
Provision (benefit) for Income Taxes                      2,383         1,832      (3,785)     (2,842)     (4,410)
------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS)                                      $  8,833      $  6,224    $ (3,842)   $ (2,890)   $ (5,782)
==================================================================================================================

SELECTED AVERAGE BALANCES
Total Assets                                           $578,090      $580,860    $642,487    $709,077    $705,516
Average Earning Assets                                  540,830       533,192     575,551     620,070     627,049
Loans                                                   394,289       406,514     481,047     514,843     515,805
Total Deposits                                          505,987       513,923     556,242     598,305     570,957
Long-Term Debt                                            6,418         8,925      28,707      45,433      47,835
Shareholders' Equity                                     49,140        43,111      40,848      46,331      48,511
Shareholders' Equity plus Loan Loss Reserve              65,407        59,094      58,794      65,322      59,999

SELECTED RATIOS
Net Income (Loss) to:
  Average Stockholders' Equity                            17.98%        14.44%      (9.41)%     (6.24)%    (11.92)%
  Average Assets                                           1.53          1.07       (0.60)      (0.41)      (0.82)
Average Stockholders' Equity to Average Total Assets       8.50          7.42       (6.36)      (6.53)      (6.88)
Common Dividend Payout Ratio                              25.00            --          --          --          -- 
Loan Loss Reserve to Total Loans at Year End               4.06          4.05        3.61        3.90        3.50
Net Charge-Offs to Average Loans                          (0.51)         1.26        3.28        1.97        1.95

PER SHARE
Basic Earnings per Common Share                        $   2.00      $   1.45    $  (0.90)   $  (0.68)   $  (1.37)
Diluted Earnings Per Common Share                          1.99          1.45       (0.90)      (0.68)      (1.37)
Cash Dividends Paid                                        0.50            --          --          --        0.20
Year End Book Value                                       11.95         10.78        9.38       10.00       10.74

OTHER
Cash Dividends Paid                                    $  2,141      $     --    $     --    $     --    $    848
</TABLE>


              MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                     CONDITION AND RESULTS OF OPERATIONS

Except for the historical information contained herein, this Annual Report 
on Form 10-K may contain forward-looking statements within the meaning of 
Section 27A of the Securities Act of 1933 and Section 21E of the Securities 
Exchange Act of 1934. Investors are cautioned that forward-looking 
statements are inherently uncertain. Actual performance and results of 
operations may differ materially from those projected or suggested in the 
forward-looking statements due to certain risks and uncertainties, 
including, without limitation, (i) the fact that the Company's success is 
dependent to a significant extent upon general economic conditions in 
Vermont and Vermont's ability to attract new business, (ii) the fact that 
the Company's earnings depend to a great extent upon the level of net 
interest income (the difference between interest income earned on loans and 
investments and the interest expense paid on deposits and other borrowings) 
generated by the Bank, and the level of net interest income and thus the 
Bank's results of operations may be adversely affected by increases or 
decreases in interest rates, (iii) the fact that the banking business is 
highly competitive and the profitability of the Company depends upon the 
Bank's ability to attract loans and deposits in Vermont, where the Bank 
competes with a variety of traditional banking and nontraditional 
institutions such as credit unions and finance companies, and (iv) the fact 
that at December 31, 1997, the Company's balance sheet loan portfolio was 
$390 million of which commercial loans represented 58.8%, exposing the 
Company to the risks inherent in financings based upon analyses of credit 
risk, the value of underlying collateral, including real estate, and other 
more intangible factors which are considered in making commercial loans. 
Accordingly, the Company's profitability may be negatively impacted by 
errors in risk analyses and by loan defaults and the ability of certain 
borrowers to repay such loans may be adversely affected by any downturn in 
general economic conditions. These factors, as well as general economic and 
market conditions, may materially and adversely affect the market price of 
the Company's common shares. Because of these and other factors, past 
financial performance should not be considered an indicator of future 
performance. The forward-looking statements contained herein represent the 
Company's judgment as of the date of this Form 10-K, and the Company 
cautions readers not to place undue reliance on such statements.

The following discussion and analysis of financial condition and results of 
operations of the Company and its subsidiaries for the three years ended 
December 31, 1997 should be read in conjunction with the consolidated 
financial statements and notes thereto and selected statistical information 
appearing elsewhere in this Annual Report on From 10-K. The information is 
discussed on a fully taxable equivalent basis. Particular attention should 
be given to the Interest Management Analysis and Five Year Summary of 
Operations tables immediately preceding this discussion upon which this 
discussion is primarily based. The financial condition and operating results 
of the Company essentially reflect the operations of its principal 
subsidiary, Merchants Bank.

RESULTS OF OPERATIONS: OVERVIEW

The Company recognized net income of $8.8 million for the year ended 
December 31, 1997, an increase of $2.6 million from 1996. There were a 
number of significant events during 1997 that contributed to this increase. 
Due to the continued strength of the Bank's asset quality, and management's 
assessment of the adequacy of the loan loss reserve as an indicator of that 
strength, the Bank discontinued providing for loan losses during the second 
quarter of 1997, after taking a $300 thousand provision in the first quarter 
of the year. During the fourth quarter of 1997 the Company recognized 
recoveries on two previously charged down loans of $2.2 million. This amount 
was credited to income through the provision for loan losses. The Company 
also recognized a gain of $840 thousand on an investment held in conjunction 
with one of the above transactions. Conversely, the Company incurred legal 
and professional expenses in conjunction with a lawsuit brought by a former 
customer totaling $1.9 million during 1997 (See "Noninterest Income and 
Expenses"). The Company also recognized losses resulting from the 
disposition of certain fixed assets in conjunction with its conversion to 
the Windows NT platform totaling $400 thousand, as well as training and 
project management costs of $395 thousand. An additional significant event 
during 1997 was a one-time contribution of $400 thousand to the Merchants 
Bank Foundation, a charitable organization created during the 1980s to 
promote community activities in Vermont. Finally, the Company made the 
decision to market for sale one of its branch properties, and plans to lease 
back the portion of the building used for the branch. A loss of $478 
thousand was recognized in conjunction with this decision in the fourth 
quarter of 1997. Core earnings (pretax earnings excluding the provision for 
loan losses and certain one-time events) increased from approximately $11.2 
million in 1996 to $12.1 million in 1997. The increase in core earnings is 
due primarily to an overall increase in earning assets from $533 million in 
1996 to $540 million in 1997, coupled with an overall decrease in interest 
bearing liabilities from $451 million in 1996 to $446 million in 1997. These 
factors coupled with the overall interest rate environment have had the 
effect of slightly increasing the Bank's net interest margin from 5.53% in 
1996 to 5.55% in 1997.

The Company recognized net income of $6.2 million for the year ended 
December 31, 1996. Core earnings (pretax earnings, excluding the provision 
for loan losses) increased from approximately $8.5 million in 1995 to $10.1 
million in 1996. This increase is attributable to several factors. The 
Company's portfolio of nonperforming loans decreased by $20.6 million from 
$27.3 million at year-end 1995 to $6.7 million at year-end 1996. 
Additionally, the Company's OREO portfolio decreased by $5.9 million from 
$7.8 million at year-end 1995 to $1.9 million at year-end 1996. The 
reductions in nonperforming asset levels allowed the Company to redeploy 
funds into earning assets and reduce administrative efforts associated with 
a nonperforming asset portfolio. Also, the Company began a reengineering 
project during 1995 to reduce ongoing operating costs through a reduction in 
workforce and improved operating efficiencies. The Company estimates that 
the changes made as a result of the reengineering have reduced noninterest 
expenses by approximately $4.6 million, and have had a marginal effect on 
noninterest income.

The Company recognized a net loss of $3.8 million for the year ended 
December 31, 1995, due primarily to the substantial provision for possible 
loan losses of $12.1 million (refer to the discussion under "Provision for 
Possible Loan Losses" that follows), and $4 million in reengineering charges 
and related consultants fees. Substantially all costs incurred and actions 
associated with the reengineering project occurred during 1995. Core 
earnings (pretax earnings excluding the provision for loan losses and 
reengineering expenses) showed slight improvement from 1994 to 1995 due 
primarily to reductions in nonperforming assets.

Basic earnings (losses) per share were $2.00, $1.45 and $(0.90) for the 
years ended December 31, 1997, 1996 and 1995, respectively. Fully diluted 
earnings per share were $1.99, $1.45 and $(0.90) for the years ended 
December 31, 1997, 1996 and 1995, respectively. In January 1997 the Company 
declared a dividend, its first since April of 1993. The Company continued 
dividends for the rest of 1997 declaring and distributing a total of $.50 
per share during 1997. In January 1998, the Company declared a dividend of 
$0.17 per share.

The net income (loss) as a percentage of average equity capital was 17.98%, 
14.44% and (9.41%) for 1997, 1996 and 1995, respectively. The ten-year 
average return on equity is 8.75% at December 31, 1997. The net income 
(loss) as a percentage of average assets was 1.53%, 1.07% and (.60%) in 
1997, 1996 and 1995, respectively. The ten-year average return on assets is 
 .64% at December 31, 1997.

YEAR 2000

The Bank is taking measures to address the impact of the Year 2000 issue on 
its information systems. The Year 2000 issue, which is common to most 
corporations, and especially important to banks, concerns the inability of 
information systems, primarily computer software programs, to properly 
recognize and process date sensitive information as the year 2000 
approaches. Since the middle of 1997, a Year 2000 Committee (the Committee) 
has been meeting and planning the actions the Bank needs to take to verify 
that the Bank, all of its' vendors, and largest borrowing customers are in 
compliance with Year 2000 requirements in advance of this millenium change. 
The Committee is chaired by the Bank's Senior Operations Officer, and 
includes the Chief Financial Officer, Chief Auditor/Risk Management Officer, 
Information Systems Manager, Senior Loan Underwriter, a Trust Company 
Officer and Facilities/Administration Manager. The Committee provides 
progress reports to the Bank's senior management and reports at least 
quarterly to the Board of Directors. The Committee has established an 
assessment process that includes contacting and requesting a Year 2000 plan 
and testing information from all vendors and the Bank's largest borrowing 
customers. The Committee has contacted 175 vendors and service providers and 
has received responses from critical vendors and service providers. The goal 
is to complete programming changes and to have testing well underway for 
mission-critical systems by December 31, 1998. Decisions regarding 
replacement of any known non-compliant equipment or software will be made as 
early in 1998 as possible. The Bank will seek to ensure that future system 
installations will be year 2000 compliant. The Bank's core software provider 
has been working to solve the Year 2000 issue for over two years, and has 
reported to the Bank that, in its' opinion, the bulk of the reprogramming is 
complete. This core software is the Bank's most significant Year 2000 risk. 
Merchants Bank is regulated by the Federal Deposit Insurance Corporation 
("FDIC"), which reviewed the Year 2000 plans during the fourth quarter of 
1997. The FDIC intends to monitor the Bank's compliance efforts on a 
quarterly basis through the year 2000. Current plans do not include the use 
of outside vendors or temporary employees. The Committee currently estimates 
that there will be costs associated with replacing certain non-compliant 
software and/or hardware. The Bank plans to replace many of its ATMs as well 
as upgrade certain software and equipment. The cost of these replacements is 
estimated to be $1.1 million, these costs will be capitalized and 
depreciated over the estimated useful lives of the assets, as such assets 
represent replacement of existing equipment. Additional expenses are 
estimated to be $135 thousand and will be expensed as incurred

NET INTEREST INCOME

Net interest income before the provision for possible loan losses is the 
difference between total interest, loan fees and investment income, and 
total interest expense. Net interest income before the provision for 
possible loan losses is a key indicator of a bank's performance in managing 
its assets and liabilities. Maximization and stability of net interest 
income is a primary objective of the Bank. From 1996 to 1997, total interest 
and dividend income increased $154 thousand (0.3%) and total interest 
expense decreased $434 thousand (2.32%). This resulted in an increase to net 
interest income before provision for possible loan losses on a fully taxable 
equivalent basis of $588 thousand (1.97%) from $29.3 million in 1996 to 
$29.9 million in 1997. A number of factors contributed to these changes. 
First, the Company's portfolio of nonperforming loans continued to decrease, 
from $6.7 million at year-end 1996 to $3.3 million at year-end 1997, and the 
Company's OREO portfolio decreased by $1.3 million from $1.9 million at 
year-end 1996 to $591 thousand at year-end 1997. Second, the Bank's overall 
loan portfolio increased by $3.2 million (0.8%), while the Bank's investment 
portfolio increased by $11.4 million (7.87%). Finally, deposits have 
decreased by $2.5 million from year-end 1996 to year-end 1997 (see "Balance 
Sheet Analysis" for a more comprehensive discussion of changes in the 
balance sheet). The yield on total interest earning assets has decreased 
from 9.03% for the year 1996 to 8.92% for the year 1997, as a result of the 
change in the composition of interest earnings assets discussed above, and 
increased competition from both bank and non-bank competitors. The cost of 
interest bearing liabilities has decreased slightly from 4.14% for the year 
1996 to 4.09% for the year 1997. This decrease in cost results from the 
Bank's continuing strategies to encourage the movement of balances from time 
deposits to money market accounts and NOW accounts. The Bank has seen its 
FreedomLYNX accounts increase by $7.3 million over the course of 1997. These 
accounts pay interest using a tiered rate structure, the current cost of 
these funds is approximately 1.76%. Rates on money market accounts were 
increased in the early part of 1997 to place the bank more competitively in 
the marketplace, and to make these types of accounts more attractive to 
investors. As interest rates fluctuate, money market accounts tend to move 
in lock step with the changes instead of lagging the market as time deposits 
typically do. Because the Bank's net interest income is more sensitive to a 
decline in rates the Bank is better served to have more of its' core funding 
in variable rate deposits. The combination of the changes discussed above 
lead to a small increase in the overall net interest margin from 5.53% for 
the year 1996 to 5.55% for the year 1997.

From 1995 to 1996, total interest income decreased $3.3 million (6.45%), and 
total interest expense decreased $4.3 million (18.8%). This resulted in an 
increase in net interest income before the provision for possible loan 
losses on a fully taxable equivalent basis of $1 million (4.20%) from $28.5 
million in 1995 to $29.5 million in 1996. A number of factors contributed to 
this change. First, the Bank's overall loan portfolio decreased by $62 
million (13.8%), while the Bank's investment portfolio increased by $46 
million (47%) (See "Balance Sheet Analysis" for a more comprehensive 
discussion of changes in the balance sheet.) This shift of funds from the 
loan portfolio to the lower yielding investment portfolio decreased the 
Bank's overall net interest income. However, the Bank decreased its 
nonperforming loan portfolio by $20.6 million (75%), which created earning 
assets and increased the yield on the overall loan portfolio from 9.61% to 
9.86%. Second, during 1995, the Company paid off $20.4 million in long term 
debt accruing at an average interest rate of 9.81%, resulting in a reduction 
in the Company's cost of funds from 4.51% in 1995 to 4.14% in 1996. Finally, 
the Bank made a strategic decision to lower the rates paid on certain 
interest-bearing checking and money market accounts, which reduced its cost 
of deposits from 4.16% in 1995 to 4.07% in 1996. These factors combined to 
increase the Company's net interest margin from 4.95% in 1995 to 5.53% in 
1996.

Total fees on loans decreased $714 thousand from $2,333 thousand in 1996 to 
$1,619 thousand in 1997. This decrease is due primarily to a strategic 
decision made by the Bank's Asset/Liability Committee a year ago to hold 
many of its originated mortgages in portfolio rather than sell them in the 
secondary market. The Bank has historically had a disproportionately low 
allocation of residential real estate mortgages in its portfolio. The 
retention of these credits in portfolio, while decreasing servicing revenue, 
will result in higher interest revenue than could be earned in the Bank's 
investment portfolio. Total fees on loans changed by an immaterial amount 
from 1995 to 1996 and had a minimal effect on the change in net interest 
income.

NONINTEREST INCOME AND EXPENSES

Net operating expense (net overhead) is total noninterest expense reduced by 
noninterest income. Operating expense includes all costs associated with 
staff, occupancy, equipment, supplies and all other noninterest expenses. 
Noninterest income consists primarily of fee income on deposit accounts, 
trust services, credit card, corporate and data processing services and 
gains or losses on investment securities.

Excluding the FDIC assistance received pursuant to the loss sharing 
agreement (see "FDIC Assisted Acquisition") of $407 thousand during 1996, 
noninterest income decreased $1 million (11.6%) from 1996 to 1997. There are 
three one-time events in the two years that effected this change. First, 
during 1997, the Bank recognized an $840 thousand gain on an investment it 
had with a zero basis. Second, during 1996, the Bank recognized a net gain 
on the sale of a bank branch of $300 thousand, and third, during 1996, the 
Bank received refunds of Vermont Franchise Tax paid in prior years of $885 
thousand. Trust Company revenue has increased $142 thousand (9.51%) in 1997 
over 1996, the result of increased marketing efforts by the Trust Company. 
Service charges on deposits have decreased $272 thousand from 1996 to 1997 
as the Bank continues to increase FreedomLYNX account balances. These 
accounts charge no fees to customers who have a direct deposit, a debit card 
or an automatic loan payment. Although there are generally no fees on these 
accounts, the average interest cost is approximately 1.76% and the average 
balance maintained by the customer is higher than a regular checking 
account. Fees received related to merchants discounts on credit cards have 
decreased by $159 thousand as a result of lower transaction volumes during 
1997.

Excluding the FDIC assistance received pursuant to the loss sharing 
agreement (see "FDIC Assisted Acquisition"), the gain on the curtailment of 
the pension plan recognized in 1995, and net gains on investment securities, 
noninterest income increased $1 million (13.35%) from 1995 to 1996. There 
were two nonrecurring items comprising the majority of the net increase: a 
net gain on the sale of a branch of $300 thousand and refunds of Vermont 
Franchise Taxes paid in prior years of $800 thousand.

Noninterest expenses increased $1.4 million (5.17%) in 1997 from 1996, 
excluding losses and write-downs on Segregated Assets reimbursed by the 
FDIC. There were several significant nonrecurring events contributing to 
this increase. The first such expense is the expenses recognized in 
conjunction with the Company's conversion to the Windows NT platform. The 
significant expenses recognized in conjunction with this conversion were 
$395 thousand in costs associated with project management and training, and 
$400 thousand recognized in conjunction with the retirement of certain not 
yet fully depreciated assets. The Company is committed to the use of 
technology to both increase efficiencies and to improve overall customer 
service. The Company plans to convert the teller system to the Windows NT 
platform during 1998, enabling our front line personnel to perform a 
multitude of tasks and access extensive customer information without leaving 
their stations. Recognizing that technology changes almost daily in the 
current environment, the Company has made the decision to depreciate current 
investments in technology based fixed assets and related software over a 
three year schedule. The second significant expense during 1997 was a $478 
thousand write-down of the Bank's branch in Brattleboro, VT when the Bank 
made the decision to sell the property and lease back the portion used for a 
branch office. One of the strategic decisions that the Company has made over 
the last year is to reduce the substantial administrative costs associated 
with being the lessor of real estate by decreasing its owned real estate 
portfolio in situations where there are large portions of the building that 
are leased to outside tenants. A third nonrecurring expense recognized 
during 1997 was a $400 thousand contribution to the Merchants Bank 
Foundation, a charitable organization established in the 1980s to support 
community activities in Vermont. Additionally, during 1997, an investment 
held by a subsidiary of the Bank was written down by $229 thousand.

Another significant factor contributing to the overall increase in 
noninterest expenses was an increase of $2 million in legal and professional 
fees, from $1.5 million for the year ended December 31, 1996 to $3.5 million 
for the year ended December 31, 1997. The increase is due primarily to 
expenses incurred by the Bank as it defended itself in litigation entitled 
Pasquale and Vatsala Vescio, Counterclaim Plaintiffs v. The Merchants Bank, 
Counterclaim Defendant, now pending in the United States Bankruptcy Court 
for the District of Vermont. For further information on this litigation see 
Part I, Item 3, Legal Proceedings.

The Bank has seen a substantial decrease in its expenses associated with 
Other Real Estate Owned (OREO), from $3.4 million in 1996 to $314 thousand 
in 1997 (90.8%). This is a direct result of the decrease in the OREO 
portfolio from $1.9 million at year-end 1996 to $591 thousand at year-end 
1997. Salaries and Wages, and associated benefits have increased from $10 
million for the year 1996 to $10.7 million for the year 1997 (6.7%). This 
increase is primarily attributable to the Company's incentive program begun 
in 1996. This program is designed to compensate employees based on their 
individual performance, as well as the performance of their individual 
divisions. The program focuses on our improved efficiency for employees in 
the service center, and on increased sales in the branches and sales 
division.

Noninterest expenses decreased $6.6 million (19.5%) in 1996 from 1995, 
excluding losses and write-downs on Segregated Assets reimbursed by the 
FDIC. Contributing significantly to this reduction were an absence of 
reengineering expenses in 1996 compared to $4.1 million in reengineering and 
related costs recognized in 1995 (see Note 10 and discussion following). 
Additionally, salaries and benefits decreased by $3.4 million (25.5%) in 
1996 from 1995 as a result of the reengineering project begun in 1995. 
Losses and write-downs of OREO increased $413 thousand from 1995 to 1996. 
This increase is due primarily to the Bank's aggressive marketing of its 
OREO portfolio and necessary adjustments to bring the value of the remaining 
properties in line with the market.

The Company recognized $1,089 thousand in low-income housing tax credits as 
a reduction in the provision for income taxes during 1997, $980 thousand 
during 1996 and $851 thousand during 1995. As a consequence of the operating 
losses incurred during 1995, the Company recognized a tax benefit of $3.8 
million, including the $851 thousand in low-income housing tax credits. 
Additionally, as of December 31, 1997, the Company has a cumulative deferred 
prepaid tax asset of approximately $4.4 million arising from timing 
differences between the Company's book and tax reporting. The prepaid tax 
asset is included in other assets.

CREDIT QUALITY AND RESERVE FOR POSSIBLE LOAN LOSSES

Improving credit quality has been a major strategic focus of the Bank since 
1994. The success of this program is evidenced by the Bank's aggressive 
reduction in the level of problem assets over the last three years. 
Nonperforming assets (loans past due 90 days or more and still accruing 
interest, nonaccruing loans, restructured loans and other real estate owned) 
decreased $4.7 million (54.65%) to $3.9 million at December 31, 1997 from 
$8.6 million at December 31, 1996. Nonperforming assets decreased 75% to 
$8.6 million at December 31, 1996 from $35.1 million at December 31, 1995.

The reserve for possible loan losses ("RPLL") was $15.8 million at December 
31, 1997 and $15.7 million at December 31, 1996. As a percentage of loans 
outstanding, the RPLL was 4.06% at year-end 1997 and 4.05% at year-end 1996. 
The provision for possible loan losses was $(1.9) million in 1997, $3.2 
million in 1996 and $12.1 million in 1995. Net charge-offs were $(2.0) 
million in 1997 and $3.7 million in 1996. The negative loan loss provision 
in 1997 resulted from a $2.16 million principal recovery received by the 
Bank during the fourth quarter of 1997 on two previously charged down 
credits. The continued high level of the RPLL reflects management's current 
strategies and efforts to maintain the reserve at a level adequate to 
provide for loan losses based on an evaluation of known and inherent risks 
in the loan portfolio. Among the factors that management considers in 
establishing the level of the reserve are overall findings from an analysis 
of individual loans, the overall risk characteristics and size of the loan 
portfolio, past credit loss history, management's assessment of current 
economic and real estate market conditions and estimates of the current 
value of the underlying collateral.

The Company takes all appropriate measures to restore nonperforming assets 
to performing status or otherwise liquidate these assets in an orderly 
fashion so as to maximize their value to the Company. There can be no 
assurances that the Bank will be able to complete the disposition of 
nonperforming assets without incurring further losses, or that the Bank will 
continue to recognize substantial recoveries such as those received during 
1997.

RISK MANAGEMENT

Management and the Board of Directors are committed to sound risk management 
practices throughout the organization. In 1997, the Company developed and 
implemented a centralized risk management monitoring program. Risks 
associated with the Company's business activities and products were 
identified and measured as to probability of occurrence and impact on the 
institution (low, moderate or high), and the control or other activities in 
place to manage those risks were identified and assessed. Periodically, 
department-level and senior managers re-evaluate and report on the risk 
management processes for which they are responsible. This documented program 
provides management with a comprehensive framework for monitoring the 
Company's risk profile from a macro perspective, while also serving as a 
tool for assessing internal controls over financial reporting as required 
under the FDIC Improvement Act.

Market Risk

Market risk is the risk of loss in a financial instrument arising from 
adverse changes in market rates/prices such as interest rates, foreign 
currency exchange rates, commodity prices, and equity prices. The Company's 
primary market risk exposure is interest rate risk. The ongoing monitoring 
and management of this risk is an important component of the Company's 
asset/liability management process which is governed by policies established 
by its Board of Directors that are reviewed and approved annually. The Board 
of Directors delegates responsibility for carrying out the asset/liability 
management policies to the Asset/Liability Committee ("ALCO"). In this 
capacity ALCO develops guidelines and strategies impacting the Company's 
asset/liability management related activities based upon estimated market 
risk sensitivity, policy limits and overall market interest rate 
levels/trends.

Interest Rate Risk

Interest rate risk is the exposure to a movement in interest rates, which 
could affect the Company's net interest income. It is the responsibility of 
the Company's ALCO to manage interest rate risk, which arises naturally from 
imbalances in repricing, maturity and/or cash flow characteristics of the 
Company's assets and liabilities. The Committee is responsible for 
developing asset/liability management strategies and tactics, and for 
ensuring that the Board of Directors receives timely, accurate information 
regarding the Bank's interest rate risk position at least quarterly. 
Techniques used by the ALCO take into consideration the cash flow and 
repricing attributes of balance sheet and off-balance sheet items and their 
relation to possible changes in interest rates. The ALCO considers the use 
of, and uses, interest rate floors to help to minimize the Bank's exposure 
to changes in interest rates. Through the use of computerized modeling 
systems, and with the assistance of outside consultants, the effect on the 
Company's net interest income of a possible 200 basis point change in 
interest rates, in rising and declining scenarios, is determined and 
evaluated by management. The Bank has established a target range for the 
change in net interest income, given a 200 basis point change in interest 
rates, of zero to 5%. As of December 31, 1997, through the use of such 
computer models, the change in net interest income for the 12 months ending 
December 31, 1998 from the Company's expected or "most likely" forecast is 
as follows:


<TABLE>
<CAPTION>
                                               Net Interest
                    Rate Change             Income Sensitivity
               -----------------------------------------------
               <S>                                <C>
               Up 200 basis points                (.46)%
               Down 200 basis points              1.35%
               -----------------------------------------------
</TABLE>

The preceding sensitivity analysis does not represent a Company forecast and 
should not be relied upon as being indicative of expected operating results. 
These hypothetical estimates are based upon numerous assumptions including: 
the nature and timing of interest rate levels, including yield curve shape, 
prepayments on loans and securities, deposit run-off rates, pricing 
decisions on loans and deposits, reinvestment/replacement of asset and 
liability cashflows, and others. While assumptions are developed based upon 
current economic and local market conditions, the Company cannot make any 
assurances as to the predictive nature of these assumptions including how 
customer preferences or competitor influences might change.

Also, as market conditions vary from those assumed in the sensitivity 
analysis, actual results will also differ due to: prepayment and refinancing 
levels likely deviating from those assumed, the varying impact of interest 
rate change caps or floors on adjustable rate assets, the potential effect 
of changes in debt service levels of customers with adjustable rate loans, 
depositor early withdrawals and product preference changes, and other 
internal or external variables. Furthermore, the sensitivity analysis does 
not reflect all actions that ALCO might take in responding to or 
anticipating changes in interest rates.

The model used to perform the simulation assumes a parallel shift of the 
yield curve over twelve months and reprices every interest-bearing asset and 
liability on the Bank's balance sheet. The model uses contractual repricing 
dates for variable products, contractual maturities for fixed rate products, 
and product-specific assumptions for deposits such as NOW accounts and Money 
Market accounts which are subject to repricing based on current market 
conditions. Investment securities with call provisions are examined on an 
individual basis in each rate environment to estimate the likelihood of a 
call. The model also assumes that the rate at which certain mortgage related 
assets prepay will vary as rates rise and fall, prepayment estimates are 
derived from the Office of Thrift Supervision Net Portfolio Value Model.

The Company has entered into interest rate floor contracts to mitigate the 
effects on net interest income in the event interest rates on floating rate 
loans decline. The notional principal amounts of contracts outstanding were 
$30 million, the amortized cost of such contracts was $69 thousand and the 
fair value of the contracts was $49 thousand as of December 31, 1997. There 
is little or no impact on the Company's net interest income as a result of 
the interest rate floors in a rising rate environment. However, in a falling 
rate environment the Company would receive payments under these contracts.

The Company's interest rate sensitivity gap ("gap") is pictured below. Gap 
is defined as the difference between assets and liabilities repricing or 
maturing within specified periods. An asset-sensitive position (positive 
gap) indicates that there are more rate-sensitive assets than rate-sensitive 
liabilities repricing or maturing within a specified time period, which 
would imply a favorable impact on net interest income during periods of 
rising interest rates. Conversely, a liability-sensitive position (negative 
gap) generally implies a favorable impact on net interest income during 
periods of falling interest rates. The Company's balance sheet is very 
closely matched, as shown below.

<TABLE>
<CAPTION>
                                                               Repricing Date
--------------------------------------------------------------------------------------------------
                                        One Day      Over Six    One Year        
                                         To Six     Months To     To Five    Over Five    
(In thousands)                           Months      One Year      Years       Years        Total
--------------------------------------------------------------------------------------------------
<S>                                     <C>          <C>         <C>          <C>         <C>
Assets                    
  Loans                                 $169,467     $34,902     $139,473     $ 40,434    $384,276
  Mortgage Backed Securities              13,123      10,033       42,377       46,357     111,890
  US Treasury & Agency Securities         10,505       9,021       24,258           --      43,784
  Other Securities                         2,296          --           --           --       2,296
  Other Assets                                --          --           --       42,006      42,006
--------------------------------------------------------------------------------------------------
Total Assets                            $195,391     $53,956     $206,108     $128,797    $584,252
==================================================================================================
Liabilities and Stockholders' Equity                    
  Noninterest-bearing Deposits                --          --           --     $ 77,054    $ 77,054
  Interest-bearing Deposits             $199,340     $54,445     $171,266        6,673     431,724
  Borrowed Funds                           8,000          --           --        6,415      14,415
  Other Liabilities                           --          --           --        7,551       7,551
  Stockholders' Equity                        --          --           --       53,508      53,508
--------------------------------------------------------------------------------------------------
Total Liabilities and Stockholders'
 Equity                                 $207,340     $54,445     $171,266     $151,201    $584,252
==================================================================================================
Cumulative Gap                           (11,949)    (12,438)      22,404        
Gap as a % of Total Earning Assets         (2.20)%     (2.29)%       4.13%
--------------------------------------------------------------------------------------------------
</TABLE>

Based on historical experience and the Bank's internal repricing policies, 
it is the Bank's practice to present repricing of statement savings, savings 
deposits, FreedomLYNX and NOW account balances divided into two repricing 
categories: 8% of such deposits are repriced in the "over six months to one 
year" category, and the balance is repriced in the "one to five year" 
category. The Bank's experience has shown that the rates on these deposits 
tend to be less rate-sensitive than other types of deposits.

Credit Risk

Credit risk is managed by a network of loan officers, with review by the 
Bank's Credit Department and oversight by the Board of Directors. The Board 
of Directors grants each loan officer the authority to originate loans on 
behalf of the Bank and establishes policies regarding loan portfolio 
diversification and loan officer lending limits. The Bank's loan portfolio 
is continuously monitored, through the use of a variety of management 
reports and with the assistance of an external loan review firm, for 
performance, creditworthiness and strength of documentation. Credit ratings 
are assigned to commercial loans and are routinely reviewed. When necessary, 
loan officers or the loan workout function take remedial actions to assure 
full and timely payment of loan balances. The Bank's policy is to 
discontinue the accrual of interest on loans when scheduled payments become 
contractually past due in excess of 90 days and the ultimate collectibility 
of principal or interest becomes doubtful. Credit card balances 90 days past 
due are charged off and consumer installment loans are charged off when they 
reach 120 days past due.

Liquidity and Capital Resource Management

Liquidity, as it pertains to banking, can be defined as the ability to 
generate cash in the most economical way to satisfy loan and deposit 
withdrawal demand, and to meet other business opportunities that require 
cash. Sources of liquidity for banks include short-term liquid assets, cash 
generated from loan repayments and amortization, borrowing, deposit 
generation and earnings. The Merchants Bank has a number of sources of 
liquid funds, including $20 million in available Federal Funds lines of 
credit at year-end 1997; an overnight line of credit with the Federal Home 
Loan Bank (FHLB) of $15 million; an estimated additional borrowing capacity 
with FHLB of $42 million; and the ability to borrow $100 million through the 
use of repurchase agreements, collateralized by the Bank's investments, with 
certain approved counterparties. Additionally, the Bank's investment 
portfolio is actively managed by the ALCO and is a strong source of cash 
flow for the Bank. The portfolio is fairly liquid, with a weighted average 
life of 3.5 years, and is available to be used as a source of funds, if 
needed.

BALANCE SHEET ANALYSIS

The Bank's overall balance sheet has not changed significantly from year-end 
1996 to year-end 1997. Total assets at December 31, 1997 increased $2.6 
million from the previous year-end. The Company's earning assets have 
increased $13.5 million (2.52%) from $534.9 million to $548.4 million. This 
increase is due to an increase in the Bank's investment portfolio (including 
FHLB stock) of $10.4 million from $147.6 million to $158 million (7.02%). 
Additionally, the Company's total loan portfolio increased $3.2 million 
(.8%) from 1996 to 1997. The composition of the Bank's loan portfolio has 
changed. Commercial mortgages have decreased $22.8 million, while commercial 
loans have increased $12.4 million and residential mortgage loans have 
increased $7.7 million. This change in the composition of the Bank's loan 
portfolio reflects the Bank's strategy to deemphasize the commercial 
mortgage portfolio as it more actively pursues small business and commercial 
credits, as well as residential mortgage loans. As part of this strategy, 
the Bank introduced a new streamlined portfolio mortgage product during the 
first quarter of 1998 which will shorten the turnaround time on residential 
mortgages with reduced documentation from borrowers. Additionally, the Bank 
introduced a new fixed rate homeline product during 1997. The balances bear 
interest at a competitive fixed rate for five years. The homeline product is 
one of the Bank's most profitable products, the risk profile is low, and the 
back office costs are lower than most of our other loan types. Additionally, 
these balances will help to mitigate the Bank's sensitivity to falling 
interest rates. The Bank's interest bearing liabilities have decreased 
slightly from $443.7 million to $443.5 million. The overall composition of 
deposits has changed somewhat year over year. Total demand deposits have 
decreased by $3.9 million, Savings, NOW and Money Market accounts have 
increased by $3.5 million, while time deposits have decreased $2.1 million. 
This shift is due primarily to the introduction of the Bank's FreedomLYNX 
account in late 1996. This account bears interest at a slight premium to the 
NOW rate on balances over $750 and requires no minimum balance. The account 
encourages the use of technology and has no maintenance fees if the 
depositor has a direct deposit, a debit card or an automatic loan payment. 

Total assets at December 31, 1996 decreased $33 million (5.43%) from the 
previous year-end. The net decrease is attributable to two major factors. 
The first factor is a decrease in the Bank's loan portfolio by $62.5 million 
over the course of 1996. Of this amount, $6.5 million resulted from the sale 
of the Bank's branch located in Danville, VT in January of 1996. 
Additionally, loans totaling $5.1 million were charged off, and the Bank 
sold loans totaling $13.2 million in bulk loan sales. The remainder of the 
decrease ($37.7 million) was the result of payouts of nonperforming 
obligations and scheduled amortization greater than the level of new loan 
originations as the Bank moved through the last phases of its reengineering 
project. The second factor contributing to the net change in total assets is 
the increase in the Bank's investment portfolio. As dollars previously 
employed in the loan portfolio became available the Bank redeployed these 
assets into its investment portfolio, resulting in a $46.5 million increase 
in the investment portfolio over the course of 1996. During 1996, the 
nonperforming loan portfolio decreased by $20.6 million (75%) and the Bank's 
OREO portfolio decreased by $5.8 million (75%). It is important to note that 
the Bank's year-end earning assets (net of nonperforming loans) increased by 
$4 million during 1996. Total deposit balances declined during 1996 by $36.2 
million (6.65%). This decrease in total assets is attributable to several 
factors. In conjunction with the sale of the Bank's branch in Danville, VT, 
$8.8 million in deposits was assumed by the buyer. Additionally, the 
uncertainty created by the combination of the announced reengineering 
project and the existing regulatory agreements, from which the Bank was 
removed in October 1996, also contributed to the total deposit balance 
decline.

The Bank began a capital improvement project to upgrade its branch 
facilities and to make further investments in technology during 1996. 
Approximately $2.8 million in 1997 and $4.1 million in 1996 was capitalized 
and will be depreciated over the estimated useful lives of the individual 
assets. Additionally, the Bank retired assets with a net book value of 
approximately $596 thousand in 1997 and $600 thousand in 1996 in connection 
with the projects; these amounts were charged to expense during the period 
in which the assets were retired.

CAPITAL RESOURCES

Capital growth is essential to support deposit and asset growth and to 
ensure strength and safety of the Company. Net income increased, and net 
losses reduced, the Company's capital by $8.8 million in 1997, $6.2 million 
in 1996 and ($3.8) million in 1995. 

The Bank and the Company are subject to various regulatory capital 
requirements administered by banking regulatory agencies. To be considered 
adequately capitalized under the regulatory framework for prompt corrective 
action, the Bank and the Company must maintain minimum Tier-1 Leverage, 
Tier-1 Risk-Based and Total Risk-Based Capital. The Bank and the Company 
were above all regulatory minimums and considered well capitalized by the 
regulators at December 31, 1997. The ratios for the Company are set forth 
below:

<TABLE>
<CAPTION>
                                                         Minimum to be
                                                       Well-Capitalized
                                                       Under Regulatory
(In thousands)                 Amount     Percentage      Guidelines
-----------------------------------------------------------------------
<S>                            <C>          <C>              <C>
Tier-1 Risk-Based Capital      $50,596      12.49%            6.0%
Total Risk-Based Capital        55,806      13.78            10.0
Tier-1 Leverage Capital         50,596       8.70             5.0
-----------------------------------------------------------------------
</TABLE>

EFFECTS OF INFLATION

The financial nature of the Company's balance sheet and statement of 
operations is more clearly affected by changes in interest rates than by 
inflation, but inflation does affect the Company because as prices increase 
the money supply tends to increase, the size of loans requested tends to 
increase, total bank assets increase, and interest rates are affected by 
inflationary expectations. In addition, operating expenses tend to increase 
without a corresponding increase in productivity. There is no precise 
method; however, to measure the effects of inflation on the Company's 
financial statements. Accordingly, any examination or analysis of the 
financial statements should take into consideration the possible effects of 
inflation.


FORM 10-K

The following is a copy, except for the exhibits, of the Annual Report of 
Merchants Bancshares, Inc. (the "Company") on Form 10-K for the year ended 
December 31, 1997, filed with the Securities and Exchange Commission (the 
"Commission").

Certain information included herein is incorporated by reference from the 
Company's 1997 Annual Report to Shareholders ("Annual Report") as indicated 
below. Except for those portions of the Annual Report which are expressly 
incorporated herein by reference, the Annual Report is not to be deemed 
filed with the Commission. The Annual Report and Form 10-K have not been 
approved or disapproved by the Commission, nor has the Commission passed 
upon the accuracy or adequacy of the same.

                              TABLE OF CONTENTS
<TABLE>
<CAPTION>
Part I                                                         Page Reference
-----------------------------------------------------------------------------
<S>                                                                <C>
Item 1--Business                                                     44
Item 2--Properties                                                 50--51
Item 3--Legal Proceedings                                          51--52
Item 4--Submission of Matters to a Vote of Security Holders          52
Part II
-----------------------------------------------------------------------------
Item 5--Market for Registrant's Common Equity and Related
         Stockholder Matters                                         53
Item 6--Selected Financial Data                                    53--61
Item 7--Management's Discussion and Analysis of Financial
         Condition and Results of Operations                       33--42
Item 7a--Quantitative and Qualitative Disclosures about
          Market Risk                                                38
Item 8--Financial Statements and Supplementary Data                 3--32
Item 9--Changes in and Disagreements with Accountants
         on Accounting and Financial Disclosures                     62
Part III *
-----------------------------------------------------------------------------
Item 10--Directors and Executive Officers of the Registrant
Item 11--Executive Compensation
Item 12--Security Ownership of Certain Beneficial Owners and Management
Item 13--Certain Relationships and Related Party Transactions
Part IV **
-----------------------------------------------------------------------------
Item 14--Exhibits, Financial Statement Schedules, and Reports on Form 8-K

Signatures

--------------------      
<F*>   The information required by Part III is incorporated herein by 
       reference from the Company's Proxy Statement for the Annual Meeting of 
       Shareholders to be held on April 21, 1998. 
<F**>  A list of exhibits in the Form 10-K is set forth on the Exhibit Index 
       included in the Form 10-K filed with the Commission and incorporated
       herein by reference. Copies of any exhibit to the Form 10-K may be
       obtained from the Company by contacting Shareholder Communications,
       Merchants Bancshares, Inc., P.O. Box 1009, Burlington, VT 05402. All
       financial statement schedules are omitted since the required
       information is included in the consolidated financial statements of
       the Company and notes thereto in the Annual Report.
</TABLE>

                                   PART I

ITEM 1--BUSINESS

Merchants Bancshares, Inc. (The "Company") is a bank holding company 
originally organized under Vermont law in 1983 for the purposes of owning 
all of the outstanding capital stock of Merchants Bank (the "Bank"), and 
providing greater flexibility in helping the Bank achieve its business 
objectives. Merchants Bank, which is the Company's primary subsidiary, is a 
Vermont Commercial Bank with 33 full-service offices.
 
The most significant event during 1997 was the beginning of the 
simplification of the Bank's retail product line with our new FreedomLYNX 
account serving as the foundation. Simple products that are easy to deliver 
and geared to the needs of our customers is the hallmark of our strategy. 
This product line has been designed to encourage our customers to make the 
fullest use of our technology, while the completion of the Bank's retail 
branch redesign, and the conversion to a common bank-wide computer platform, 
has enabled Bank employees to work far more effectively and efficiently. 
This combination of technology, simplification and efficiency has resulted 
in significant increases in retail sales. The Bank believes that its 
continued emphasis on providing personalized and customized service to the 
communities it serves, while taking full advantage of the technology 
available, gives it an advantage over the competition.

A chronology of events, including acquisitions, relating to MERCHANTS 
BANCSHARES, INC., is as follows:

      July 1, 1983: Merchants Bancshares, Inc. was organized as a Vermont 
      corporation, for the purpose of acquiring, investing in or holding 
      stock in any subsidiary enterprise under the Bank Holding Company 
      Act of 1956.

      January 24, 1984: The Company acquired The Merchants Bank, a Vermont 
      chartered commercial bank.

      June 2, 1987: Company shareholders approved a resolution to change 
      the state of incorporation of the Company from Vermont to Delaware.

      October 4, 1988: The Company organized Merchants Properties, Inc., 
      whose mission is described below.

MERCHANTS BANK, was organized in 1849, and assumed a national bank charter 
in 1865, becoming The Merchants National Bank of Burlington, Vermont. On 
September 6, 1974 the Bank converted its national charter to a state-bank 
charter, becoming known as The Merchants Bank. Since 1971 the Bank has 
acquired by merger seven Vermont banking institutions, and has acquired the 
deposits of an eighth bank located in St. Johnsbury, Vermont. The last such 
acquisition occurred on June 4, 1993 at which time the Bank acquired the New 
First National Bank of Vermont, with thirteen banking offices, from the 
Federal Deposit Insurance Corporation Division of Liquidation. As of 
December 31, 1997 the Bank was one of the largest commercial banking 
operations in Vermont, with deposits totaling $505.8 million, net loans of 
$374.6 million, and total assets of $584.3 million, on a consolidated basis.

Since September 30, 1988, the Bank has participated as an equity partner in 
the development of several affordable housing partnerships, which were 
formed to provide residential housing units within the State of Vermont. 
During the past four years these partnerships have developed 727 units of 
residential housing, 494 (68%) of which qualify as "affordable housing units 
for eligible low-income owners or renters", and 233 (32%) of which are 
"market rate units." These partnerships have invested in 16 affordable and 
elderly housing projects within 13 Vermont communities: St. Albans, 
Middlebury, Williston, Winooski, Brattleboro, Montpelier, Burlington, 
Springfield, St. Johnsbury, Colchester, Swanton, Bradford and Hardwick.

MERCHANTS PROPERTIES, INC., a wholly owned subsidiary of the Company, was 
organized for the purpose of developing and owning affordable rental housing 
units throughout the state of Vermont. As of December 31, 1997 Merchants 
Properties, Inc. owned one development located in Enosburg, Vermont, 
consisting of a 24-unit low-income family rental housing project, which was 
completed and rented during 1989. This housing development is fully occupied 
at this time. Total assets of this corporation at December 31, 1997 were 
$1.2 million.

MERCHANTS TRUST COMPANY (the "Trust Company"), a wholly owned subsidiary of 
Merchants Bank, is a Vermont corporation chartered in 1870 for the purpose 
of offering fiduciary services such as estate settlement, testamentary 
trusts, guardianships, agencies, intervivos trusts, employee benefit plans 
and corporate trust services. The Trust Company also operates a discount 
brokerage office through Olde Discount Corporation, enabling investors to 
purchase or sell stocks and bonds on a discounted commission schedule. As of 
December 31, 1997, the Trust Company had fiduciary responsibilities for 
assets valued at market in excess of $333 million, of which more than $199 
million were managed assets. Total revenue for 1997 was $1.6 million; total 
expenses were $1.3 million resulting in pretax net income of $354 thousand 
for the year. This net income is included in the consolidated tax return of 
its parent company, the Merchants Bank.

QUENESKA CAPITAL CORPORATION, previously a wholly owned subsidiary of 
Merchants Bank was established on April 4, 1988 as a Federal licensee under 
the Small Business Act of 1958 to provide small business enterprises with 
loans and/or capital. In December 1997 the corporation was dissolved.

RETAIL SERVICES

The Bank offers a variety of consumer financial products and services 
designed to satisfy the deposit and loan needs of its retail customers. The 
Bank's retail products include interest-bearing and noninterest-bearing 
checking accounts, money market accounts, passbook and statement savings, 
club accounts, and short-term and long-term certificates of deposit. The 
Bank also offers customary check collection services, wire transfers, safe 
deposit box rentals, and automated teller machine (ATM) cards and services.

In 1997, the Bank continued its commitment to automation by introducing a 
debit card and by expanding its automated overdraft protection. Using the 
BankLYNX Check Card, customers can pay for purchases at locations that 
accept VISA, and can also use the card for standard ATM transactions. With 
expanded automated overdraft protection, customers can use a savings account 
and/or a home equity line of credit as overdraft protection for a checking 
account. The customer may choose either or both accounts to cover 
overdrafts. 

During 1997, Merchants Bank expanded the qualifications for its FreedomLYNX 
checking account. FreedomLYNX checking is available with no service charges 
to customers who have, at least monthly, an automatic deposit to the account 
or an automatic debit from the account to pay a Merchants Bank loan and to 
customers who qualify for a BankLYNX Check Card or who use PhoneLYNX or 
PCLYNX Bill Payment Services. The account pays interest on higher balances 
with a tiered rate structure. No minimum balance is required. The Bank 
continues to offer Bottom Line Checking, an account that provides for a flat 
service charge up to a maximum number of checks.

The Bank continues to offer ATM cards, ATF (automatic transfer of funds) to 
cover overdrafts, EFT (electronic funds transfer) to automate transfers 
between accounts, PCLYNX bill payment services and the PCLYNX telephone 
banking system. In 1998, the Bank plans to expand its automated services by 
introducing a retail home banking system. 

The Bank continues to provide strong customer service via 33 full-service 
banking office and 35 ATM locations throughout Vermont. 

COMMERCIAL SERVICES

The restructuring of the Sales organization has been completed. Each branch 
office is led by a branch president or manager who has consumer lending 
authority for the full range of retail credit services. Additionally, branch 
presidents are being given small business lending authority up to a 
prescribed limit. All 33 of our full service branches are led by branch 
presidents. The eleven corporate banking officers and eight corporate 
banking administrators provide commercial credit services throughout the 
state of Vermont to customers requiring business credit above the prescribed 
authorities of the branch presidents.

Merchants Bank offers a variety of commercial checking accounts. Commercial 
Checking uses an earnings credit rate to help offset service charges. Small 
Business Checking is designed for the smaller business carrying lower 
balances and reduced account activity. 

Investment opportunities are available to businesses in the form of savings 
accounts and money market accounts. The Bank's cash management services 
provide additional investment opportunities through the Cash Sweep Program. 
Other cash management services include funds concentration.

The Bank offers on-line banking services through PCLYNX Corporate and PCLYNX 
Small Business. These products allow businesses to view their account 
histories, order stop payments, transfer between accounts, transmit ACH 
batches and order both domestic and foreign wire transfers. 

Other miscellaneous commercial banking services include night depository, 
coin and currency handling, lockbox and balance reporting services. Employee 
benefits management and related fiduciary services are available through the 
Merchants Trust Company.

TYPES OF CREDIT OFFERINGS

Consumer Loans:
---------------

Financing is provided for new or used automobiles, boats, airplanes, 
recreational vehicles and new mobile homes. Home improvement and home equity 
lines of credit, Master Card credit cards and various collateral loans and 
personal loans are also available.

Real Estate Loans: 
------------------

Financing is available for one-to-four-family residential mortgages; 
multifamily mortgages; residential construction; mortgages for seasonal 
dwellings; and commercial real estate mortgages. The Bank offers both fixed 
rate and adjustable rate mortgages for residential properties. Biweekly 
payment and graduated (two-step) payment products are offered. Loans under 
the Farmers Home Administration Rural Guaranteed Housing Program provide up 
to 100% financing. The Bank also participates with the Vermont Housing 
Finance Agency (VHFA) in providing mortgage financing for low- to moderate-
income Vermonters. Most mortgage loan products are offered with as little as 
a 5% down payment to assist borrowers who qualify, provided that the 
mortgagor(s) acquires private mortgage insurance.

Commercial Loans:
-----------------
Financing for business inventory, accounts receivable, fixed assets, lines 
of credit for working capital, community development, irrevocable letters of 
credit, business credit cards and U.S. Small Business Administration loans 
are available.

COMPETITION 

The Bank competes for deposit and loan business with numerous other 
commercial and savings banks, savings and loan associations, credit unions, 
and other non-bank financial providers. As of December 31, 1997, there were 
more than 30 state and national banking institutions operating in Vermont. 
In addition, the number of other financial service providers competing in 
Vermont has increased dramatically. As a bank holding company and state-
chartered bank, respectively, the Company and the Bank are subject to 
extensive regulation and supervision, including, in many cases, regulation 
which limits the type and scope of their activities. These non-financial 
institutions who compete with the Company and the Bank are not subject to 
such extensive regulation and supervision.

At year-end 1997, the Bank was one of the largest state chartered banks in 
Vermont, enjoying a strong competitive franchise within the state, with 34 
banking offices as identified in Item 2 (A). 

Consolidation within the overall banking industry continues to change the 
competitive environment in which we operate. Competition from nationwide 
banks, as well as local institutions, is expected to be aggressive. However, 
there may be opportunities for business development by the Bank in shared 
market communities as a result of the continued consolidation in the banking 
industry.

No material part of the Bank's business is dependent upon one, or a few, 
customers, or upon a particular market segment, the loss of which would have 
a materially adverse impact on the operations of the Bank. 

NUMBER OF EMPLOYEES

As of December 31, 1997, Merchants Bancshares, Inc. had three officers: 
Joseph L. Boutin, President and Chief Executive Officer; Jennifer L. Varin, 
Secretary; and Janet P. Spitler, Treasurer. No officer of the Company is on 
a salary basis.

As of December 31, 1997, Merchants Bank employed 216 full-time and 87 part-
time employees, representing a full-time equivalent complement of 243.14 
employees; the Merchants Trust Company employed 14 full-time and 1 part-time 
employees, representing a full-time equivalent complement of 14.6 employees. 
The Bank and the Trust Company maintain comprehensive employee benefits 
programs which provide major medical insurance, hospitalization, dental 
insurance, long-term and short-term disability insurance, life insurance and 
a 401(k) Employee Stock Ownership Plan. Employee benefits offered by the 
Bank and the Trust Company are very competitive with comparable plans 
provided by similar Vermont institutions.

REGULATION AND SUPERVISION

General

As a bank holding company registered under the Bank Holding Company Act of 
1956, as amended (the "BHCA"), the Company is subject to substantial 
regulation and supervision by the Federal Reserve Board. As a state-
chartered bank, the Bank is subject to substantial regulation and 
supervision by the Federal Deposit Insurance Corporation (the "FDIC") and by 
applicable state regulatory agencies. To the extent that the following 
information describes statutory or regulatory provisions, it is qualified in 
its entirety by reference to those particular statutory provisions. Any 
change in applicable law or regulation may have a material effect on the 
business and prospects of the Company and the Bank.

The Company is required by the BHCA to file with the Federal Reserve Board 
an annual report and such additional reports as the Federal Reserve Board 
may require. The Federal Reserve Board also makes periodic inspections of 
the Company and its subsidiaries. The BHCA requires every bank holding 
company to obtain the prior approval of the Federal Reserve Board before it 
may acquire substantially all of the assets of any bank, or ownership or 
control of any voting shares of an bank, if, after such acquisition, it 
would own or control, directly or indirectly, more than 5% of the voting 
shares of such bank. Additionally, as a bank holding company, the Company is 
prohibited from acquiring ownership or control of 5% or more of any company 
not a bank or from engaging in activities other than banking or controlling 
banks except where the Federal Reserve Board has determined that such 
activities are so closely related to banking as to be a "proper incident 
thereto."

Dividends

General. The Company is a legal entity separate and distinct from the Bank 
and its other nonbank subsidiaries. The revenue of the Company (on a parent 
company only basis) is derived primarily from interest and dividends paid to 
the corporation by its subsidiaries. The right of the Company, and 
consequently the right of stockholders of the Company, to participate in any 
distribution of the assets or earnings of any subsidiary through the payment 
of such dividends or otherwise is necessarily subject to the prior claims of 
creditors of the subsidiary (including depositors, in the case of banking 
subsidiaries), except to the extent that certain claims of the Company in a 
creditor capacity may be recognized.

The payment of dividends by the Company is determined by its board of 
directors based on the Company's liquidity, asset quality profile, capital 
adequacy, and recent earnings history, as well as economic conditions and 
other factors, including applicable government regulations and policies and 
the amount of dividends payable to the Company by its subsidiaries.

It is the policy of the Federal Reserve Board that banks and bank holding 
companies, respectively, should pay dividends only out of current earnings 
and only if after paying such dividends the bank or bank holding company 
would remain adequately capitalized. Federal banking regulators also have 
authority to prohibit banks and bank holding companies from paying dividends 
if they deem such payment to be unsafe or unsound practice. In addition, it 
is the position of the Federal Reserve Board that a bank holding company is 
expected to act as a source of financial strength to its subsidiary banks.

State law requires the approval of state bank regulatory authorities if the 
dividends declared by state banks exceed prescribed limits. The payment of 
any dividends by the Company's subsidiaries will be determined based on a 
number of factors, including the subsidiary's liquidity, asset quality 
profile, capital adequacy and recent earnings history.

Legislation and Related Matters

General. In addition to extensive existing government regulation, federal 
and state statutes and regulations are subject to changes that may have 
significant impact on the way in which banks may conduct business. The 
likelihood and potential effects of any such changes cannot be predicted. 
Legislation enacted in recent years has substantially increased the level of 
competition among commercial banks, thrift institutions and non-banking 
institutions, including insurance companies, brokerage firms, mutual funds, 
investment banks, finance companies and major retailers. In addition, the 
existence of banking legislation such as the Federal Deposit Insurance 
Corporation Improvement Act of 1991 ("FDICIA") have affected the banking 
industry by, among other things, broadening the regulatory powers of the 
federal banking agencies in a number of areas. The following summary is 
qualified in its entirety by the text of the relevant statutes and 
regulations.

FDICIA. The FDICIA, which was enacted on December 19, 1991, provides for, 
among other things, increased funding for the Bank Insurance Fund ("BIF") of 
the FDIC and expanded regulation of depository institutions and their 
affiliates, including parent holding companies. A summary of certain 
material provisions of FDICIA and its regulations is provided below.

Prompt Corrective Action. The FDICIA provides the federal banking agencies 
with broad powers to take prompt corrective action to resolve problems of 
insured depository institutions, depending upon a particular institution's 
level of capital. The FDICIA establishes five tiers of capital measurement 
for regulatory purposes ranging from "well-capitalized" to "critically 
undercapitalized." A depository institution may be deemed to be in a 
capitalization category that is lower than is indicated by its actual 
capital position under certain circumstances. As of December 31, 1997, the 
Bank was classified as "well-capitalized" under the applicable prompt 
corrective action regulations.

Brokered Deposits. Under the FDICIA, a depository institution that is well-
capitalized may accept brokered deposits. A depository institution that is 
adequately capitalized may accept brokered deposits only if it obtains a 
waiver from the FDIC, and may not offer interest rates on deposits 
"significantly higher" than the prevailing rate in its market. An 
undercapitalized depository institution may not accept brokered deposits. 

Safety and Soundness Standards. The FDICIA, as amended, directs each federal 
banking agency to prescribe safety and soundness standards for depository 
institutions relating to internal controls, information systems, internal 
audit systems, loan documentation, credit underwriting, interest rate 
exposure, asset growth, compensation, asset-quality, earnings and stock 
valuation. The Community Development and Regulatory Improvement Act of 1994 
amended FDICIA by allowing federal banking activities to publish guidelines 
rather than regulations concerning safety and soundness.

The Federal Reserve Board has finalized these safety and soundness 
guidelines. These guidelines relate to the management policies of financial 
institutions and are designed, in large part, to implement the safety and 
soundness criteria outlined in FDICIA. These guidelines will be published 
after the other federal bank regulatory agencies have developed their 
guidelines. At this time, it is not known what effect the applicable 
guidelines will have on the current practices of the Company or the Bank.

FDICIA also contains a variety of other provisions that may affect the 
Company's and the Bank's operations, including reporting requirements, 
regulatory guidelines for real estate lending, "truth in savings" 
provisions, and the requirement that a depository institution give 90 days' 
prior notice to customers and regulatory authorities before closing any 
branch. Certain of the provisions in FDICIA have recently been or will be 
implemented through the adoption of regulations by the various federal 
banking agencies and, therefore, their precise impact cannot be assessed at 
this time.

Capital Guidelines. Under the uniform capital guidelines adopted by the 
federal banking agencies, a well-capitalized institution must have a minimum 
ratio of total capital to risk-adjusted assets (including certain off-
balance sheet items, such as standby letters of credit) of 10%, a minimum 
Tier 1 (comprised of common equity, retained earnings, minority interests in 
the equity accounts of consolidated subsidiaries and a limited amount of 
noncumulative perpetual preferred stock, less deductible intangibles) 
capital-to-total risk based assets of 6% and a minimum leverage ratio (Tier 
1 capital to average quarterly assets, net of goodwill), of 5%. 

Under federal banking laws, failure to meet the minimum regulatory capital 
requirements could subject a banking institution to a variety of enforcement 
remedies available to federal regulatory authorities, including the 
termination of deposit insurance by the FDIC and seizure of the institution.

Community Investment Act. Pursuant to the Community Reinvestment Act ("CRA") 
and similar provisions of Vermont law, regulatory authorities review the 
performance of the Company and the Bank in meeting the credit needs of the 
communities served by the Bank. The applicable regulatory authorities 
consider compliance with this law in connection with the applications for, 
among other things, approval of branches, branch relocations and 
acquisitions of banks and bank holding companies. The Bank received a 
"satisfactory" rating at its most recent CRA examination.

Interstate Banking As of September 29, 1995, the Riegle-Neal Interstate 
Banking and Branching Efficiency Act of 1994 (the "RNA") permitted 
adequately capitalized and managed bank holding companies to acquire control 
of banks in any state. Additionally, beginning on June 1, 1997, the RNA 
provides for banks to branch across state lines, although individual states 
are authorized to permit interstate branches earlier or to elect to opt out 
entirely.

Other Proposals

Other legislative and regulatory proposals regarding changes in banking, and 
the regulation of banks and other financial institutions, are regularly 
considered by the executive branch of the federal government, Congress and 
various state governments, including Vermont, and state and federal 
regulatory authorities. It cannot be predicted what additional legislative 
and/or regulatory proposals, if any, will be considered in the future, 
whether any such proposals will be adopted or, if adopted, how any such 
proposals would affect the Company or the Bank.


ITEM 2--PROPERTIES

A.    SCHEDULE OF BANKING OFFICES BY LOCATION

Merchants Bank operates thirty-five banking facilities as indicated in 
Schedule A below. Corporate administrative offices and the operations data 
processing center are located at 275 Kennedy Drive, South Burlington, 
Vermont.

<TABLE>

<S>                 <C>                                    <S>
Burlington          164 College Street                     Merchants Trust Company
                    172 College Street                     Branch office
                    1014 North Avenue                      Branch office
        
Essex Junction      54 Pearl Street                        Branch office
        
South Burlington    50 White Street                        Branch office
                    929 Shelburne Road(1)                  Branch office
                    275 Kennedy Drive                      Service Center
                                                           Corporate Offices
                                                           Branch office
                    Burlington International Airport(1)    ATM
        
Bristol             15 West Street                         Branch office
        
Barre               105 North Main Street(2)               Branch office
        
Northfield          47 Depot Square(2)                     Branch office
        
South Hero          South St. & Route 2                    Branch office
        
Hardwick            Wolcott Street & Route 15              Branch office
        
Hinesburg           Route 116/Shelburne Falls Rd           Branch office
        
Vergennes           Monkton Road                           Branch office
        
Winooski            364 Main Street                        Branch office
        
Shelburne           200 Wake Robin Drive(2)                Branch office
        
Johnson             Main Street, Route 15                  Branch office
        
Colchester          8 Porters Point Road(2)                Branch office
        
Jericho             Route 15                               Branch office
        
Enosburg Falls      155 Main Street                        Branch office
        
No. Bennington      Bank Street                            Branch office
        
Manchester Center   Route 7A                               Branch office
        
Brattleboro         205 Main Street(3)                     Branch office
                    Fairfield Plaza(2)                     ATM
        
Wilmington          West Main Street                       Branch office

Bennington          Putnam Square(2)                       Branch office
        
Wallingford         Route 7(2)                             Branch office
        
St. Johnsbury       90 Portland Street                     Branch office
        
Bradford            1 Main Street & Operations Building    Branch office
        
Fairlee             U.S. Route #5(2)                       Branch office
        
Groton              258 Scott Highway                      Branch office
        
East Thetford       U.S. Route #5 & VT 113(2)              Branch office
        
Newbury             U.S. Route #5                          Branch office
        
Fair Haven          97 Main Street                         Branch office
                    Washington Street Grand Union(1)       ATM
        
Springfield         Springfield Shopping Plaza             Branch office
                    56 Main Street(2)                      ATM
        
Windsor             160 Main Street                        Branch office

--------------------      
<F1>  Facilities owned by the Bank are located on leased land.
<F2>  Facilities located on leased land with improvements also leased.
<F3>  As of December 31, 1997, a mortgage with an unpaid principal balance 
      of $200 thousand is outstanding on the Brattleboro office. This 
      mortgage is being amortized at $2 thousand per month, at a rate of 9% 
      through the year 2020.
</TABLE>

ITEM 3--LEGAL PROCEEDINGS

The Bank is a counterclaim defendant in a litigation entitled Pasquale and 
Vatsala Vescio, Counterclaim Plaintiffs v. The Merchants Bank, Counterclaim 
Defendant, now pending in the United States Bankruptcy Court for the 
District of Vermont.

In this litigation, the Vescios have made a number of "lender liability" 
claims dealing with a commercial development known as Brattleboro West in 
Brattleboro, Vermont. The pending litigation arose out of a suit to 
foreclose on several real estate mortgages and personal property originally 
granted to the Bank by the Vescios in connection with the financing of a 
supermarket in the Brattleboro West project and various other projects.

Among other things, the Vescios have alleged that the Bank or its 
representatives violated supposed oral promises in connection with the 
origination and funding of the financing, and have claimed that the Bank is 
liable to them for damages based on the Bank's supposed "control" of the 
project and its alleged breach of covenants of "good faith" which the 
plaintiffs believe are to be implied from the loan documents. In addition, 
the plaintiffs have contended that the Bank breached some kind of duty of 
care they believe it owed to them, and have claimed that the Bank should not 
have exercised its contract rights when the loan went into default, but 
should have worked out the default in a way that was more favorable to the 
borrowers. The parties have conducted extensive discovery and the matter is 
now being tried in the Bankruptcy Court for the District of Vermont. 
Although it is not possible at this stage to predict the outcome of this 
litigation, the Bank believes that it has meritorious defenses to the 
plaintiffs' allegations. The Bank intends to vigorously defend itself again 
these claims.

The Company, the Bank, the Trust Company (the "Companies") and certain of 
their directors are defendants in a lawsuit filed in November of 1994 (the 
"Vermont Proceedings"). The Vermont Proceedings arose from certain 
investments managed for Trust Company customers and placed into the Piper 
Jaffray Institutional Government Income Portfolio (the "Portfolio"). In 
December of 1994, the Companies made payments to the Trust Company customers 
in amounts that the Companies believe reimbursed those customers fully for 
Portfolio losses. The United States District Court for the District of 
Vermont has dismissed the Plaintiff's claims in the Vermont Proceedings with 
prejudice, as moot, and has ordered payment of approximately $99,000 in 
attorneys fees to the attorneys representing the Plaintiff. The Plaintiff 
and his attorneys have appealed to the Second Circuit Court of Appeals the 
District Court's orders, and the Companies have appealed on certain limited 
issues.

The Companies have separately pursued claims against others on account of 
the losses suffered as a result of the investments in the Portfolio. Claims 
against Piper Jaffray Companies, Inc. were joined with the claims of others 
in a class action in the United States District Court for the District of 
Minnesota (the "Minnesota Proceedings"). The Minnesota Proceedings were 
settled by the parties and in February of 1997 the District Court ordered 
the net share of the settlement proceeds attributable to the Trust Company's 
investments to be paid to the Trust Company, starting approximately sixty 
days after the Court's order becomes final, except to the extent, if at all, 
any other court with jurisdiction has sooner given leave for some or all of 
those payments to be deposited with such other court pursuant to applicable 
rules. The attorneys representing the Plaintiff in the Vermont Proceedings 
and also representing, in the Minnesota Proceedings, the beneficiaries of 
four other Trust Company accounts, have appealed that order to the Eighth 
Circuit Court of Appeals. Those attorneys have taken the position that 
notwithstanding the payments made by the Companies to the Trust Company 
customers in December of 1994, any amounts paid under the Minnesota 
Proceedings on account of the Trust Company's Portfolio investments should 
be paid directly to the affected Trust Company customers (net of legal fees 
to be paid to those attorneys). Any recovery by the Companies from the 
Minnesota Proceedings is subject to the terms of an agreement between the 
Companies and their insurance carrier, which reimbursed the Companies, in 
part, for the December, 1994 payments.

Merchants Bancshares, Inc. and certain of its subsidiaries have been named 
as defendants in various legal proceedings arising from their normal 
business activities. Although the amount of any ultimate liability with 
respect to such proceedings cannot be determined, in the opinion of 
management, based upon the opinion of counsel on the outcome of such 
proceedings, any such liability will not have a material effect on the 
consolidated financial position of Merchants Bancshares, Inc. and its 
subsidiaries.

ITEM 4--SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

During the fourth quarter of calendar year 1997 no matters were submitted to 
a vote of security holders through a
solicitation of proxies or otherwise.


PART II

ITEM 5--MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
        STOCKHOLDER MATTERS

The common stock of the Company is traded on the over-the-counter market and 
the price is quoted on the Nasdaq National Market Stock Exchange under the 
trading symbol MBVT. Quarterly stock prices during the last eight quarters 
are as indicated below based upon quotations as provided by the National 
Association of Securities Dealers, Inc. Prices of transactions between 
private parties may vary from the ranges quoted below.

<TABLE>
<CAPTION>
             Quarter Ended                      High      Low
             --------------------------------------------------
             <S>                               <C>       <C>
             December 31, 1997                 33.500    26.000
             September 30, 1997                29.000    20.500
             June 30, 1997                     21.125    18.000
             March 31, 1997                    21.250    18.250
             December 31, 1996                 19.375    15.000
             September 30, 1996                16.000    15.000
             June 30, 1996                     16.375    14.250
             March 31, 1996                    16.000    13.250
             --------------------------------------------------
</TABLE>

As of March 6, 1998, Merchants Bancshares, Inc. had 1,281 registered 
shareholders. In January 1997, the Company declared a dividend, its first 
since April 1993. The Company continued dividends for the rest of 1997, 
declaring and distributing a total of $.50 per share during 1997. In January 
1998, the Company declared a dividend of $.0.17 per share. Future dividends 
will depend upon the financial condition and earnings of the Company and its 
subsidiaries, their need for funds and other factors, including applicable 
government regulations.

ITEM 6--SELECTED FINANCIAL DATA

The supplementary financial data presented in the following tables and 
narrative contain information highlighting certain significant trends in the 
Company's financial condition and results of operations over an extended 
period of time.

The following information should be analyzed in conjunction with the year-
end audited consolidated financial statements as contained in the 1997 
Annual Report to Shareholders, a copy of which is attached as an addendum to 
this Form 10-K.

The five-year summary of operations, interest management analysis and 
management's discussion and analysis, all as contained on pages 31 through 
42 of the 1997 Annual Report to Shareholders, are herein incorporated by 
reference.

Tables included on the following pages 53 through 57 concern the following:

Deposits; return on equity and assets; short-term borrowings; distribution 
of assets, liabilities, and stockholders' equity; analysis of changes in net 
interest income; and the composition and maturity of the loan portfolio.

DEPOSITS

The following schedule shows the average balances of various classifications 
of deposits:

<TABLE>
<CAPTION>
       (In thousands)                  1997        1996        1995
       --------------------------------------------------------------
       <S>                           <C>         <C>         <C>
       Demand Deposits               $ 75,972    $ 78,873    $ 87,434
       Savings, Money Market and			       
        Now Accounts                  265,578     264,611     279,906
       Time Deposits $100,000 and
        Greater                        19,750      20,059      20,927
       Other Time Deposits            144,687     150,380     167,975
       --------------------------------------------------------------
       Total Average Deposits        $505,987    $513,923    $556,242
       ==============================================================
</TABLE>

Time Deposits $100 thousand and greater at December 31, 1997 had the 
following schedule of maturities:

<TABLE>
<CAPTION>
                     (In thousands)    
                     ----------------------------------
                     <S>                        <C>
                     Three Months or Less       $ 4,431
                     Three to Six Months          3,512
                     Six to Twelve Months         4,436
                     Over Twelve Months           4,254
                     Over Five Years              6,674
                     ----------------------------------
                                                $23,307
                     ==================================
</TABLE>

RETURN ON EQUITY AND ASSETS

The return on average assets, return on average equity, dividend payout 
ratio and average equity to average assets ratio for the three years ended 
December 31, 1997 were as follows:

<TABLE>
<CAPTION>
                                           1997     1996       1995
---------------------------------------------------------------------
<S>                                       <C>       <C>       <C>
Return on Average Total Assets             1.53%     1.07%    (0.60%)
Return on Average Stockholders' Equity    17.98%    14.44%    (9.41%)
Dividend Payout Ratio                        25%     N/A        N/A
Average Stockholders' Equity to
 Average Total Assets                       8.5%     7.42%     6.36%
---------------------------------------------------------------------
</TABLE>

SHORT-TERM BORROWINGS

Refer to Note 8 to the Financial Statements for this information. 

The following table presents the condensed annual average balance sheets for 
1997, 1996 and 1995. The total dollar amount of interest income from assets 
and the subsequent yields calculated on a taxable equivalent basis as well 
as the interest paid on interest bearing liabilities, expressed in dollars 
and rates are also shown in the table.


                         Merchants Bancshares, Inc.
   Distribution of Assets, Liabilities and Stockholders' Equity; Interest
                       Rates and Interest Differential

<TABLE>
<CAPTION>
                                                1997                            1996                            1995
---------------------------------------------------------------------------------------------------------------------------------
                                               Interest   Average              Interest   Average              Interest   Average
                                    Average    Income/     Yield/   Average    Income/     Yield/   Average    Income/     Yield/
(In thousands)                      Balance    Expense      Rate    Balance    Expense      Rate    Balance    Expense      Rate
---------------------------------------------------------------------------------------------------------------------------------
<S>                                 <C>        <C>        <C>       <C>        <C>        <C>       <C>        <C>        <C>
ASSETS:                                    
  Investment Securities:
    U.S. Treasury and Agencies      $142,070   $ 9,443     6.65%    $117,908   $ 7,588     6.44%    $ 83,749   $ 4,525     5.40%
    Other, Including FHLB Stock        2,435       172     7.06%       2,865       148     5.17%       4,416       357     8.08%
--------------------------------------------------------------------------------------------------------------------------------- 
      Total Investment Securities    144,505     9,615     6.65%     120,773     7,736     6.41%      88,165     4,882     5.54%
---------------------------------------------------------------------------------------------------------------------------------

  Loans, Including Fees on
   Loans(a)(b):                                    
    Commercial                        68,036     7,479    10.99%      68,783     7,281    10.59%      87,009     9,236    10.61%
    Real Estate                      311,490    29,286     9.40%     322,690    31,135     9.65%     378,433    35,094     9.27%
    Consumer                          14,763     1,763    11.94%      15,041     1,673    11.12%      15,605     1,902    12.19%
---------------------------------------------------------------------------------------------------------------------------------
                                    
Total Loans                          394,289    38,528     9.77%     406,514    40,089     9.86%     481,047    46,232     9.61%
                                    
    Federal Funds Sold                 2,036       111     5.45%       5,905       315     5.33%       6,339       366     5.77%
---------------------------------------------------------------------------------------------------------------------------------
                                    
Total Earning Assets                 540,830    48,254     8.92%     533,192    48,140     9.03%     575,551    51,480     8.94%
---------------------------------------------------------------------------------------------------------------------------------
                                    
  Reserve for Possible Loan Losses   (16,267)                        (15,983)                        (17,946)
  Cash and Due From Banks             22,833                          28,907                          34,099
  Premises and Equipment              14,513                          13,298                          15,365 
  Other Assets                        16,181                          21,446                          35,418
---------------------------------------------------------------------------------------------------------------------------------
                                    
Total Assets                        $578,090                        $580,860                        $642,487        
=================================================================================================================================
LIABILITIES AND
 STOCKHOLDERS' EQUITY:                                    
  Time Deposits:                                    
    Savings, Money Market &
     NOW Accounts                   $265,578   $ 8,452     3.18%    $264,611   $ 8,217     3.11%    $279,906   $ 9,077     3.24%
    Time Deposits $100 thousand
     and Greater                      19,750       821     4.16%      20,059     1,396     6.96%      20,927     1,433     6.85%
        Other Time                   144,687     8,043     5.56%     150,380     8,112     5.39%     167,975     8,981     5.35%
---------------------------------------------------------------------------------------------------------------------------------
  Total Time Deposits                430,015    17,316     4.03%     435,050    17,725     4.07%     468,808    19,491     4.16%
                                    
  Federal Funds Purchased                906        54     5.96%         704        32     4.59%         975        58     5.95%
  Demand Notes Due U.S. Treasury       2,463       130     5.28%       2,134       108     5.04%       3,229       173     5.36%
  Other Short-Term Borrowings          5,925       307     5.18%       4,206       205     4.88%       4,524        44     0.97%
  Long-Term Debt                       6,417       431     6.72%       8,925       602     6.75%      32,819     3,236     9.86%
---------------------------------------------------------------------------------------------------------------------------------
Total Interest Bearing Liabilities   445,726    18,238     4.09%     451,019    18,672     4.14%     510,355    23,002     4.51%
---------------------------------------------------------------------------------------------------------------------------------
  Demand Deposits                     75,972                          78,873                          87,434        
  Other Liabilities                    7,252                           7,857                           3,850        
  Stockholders' Equity                49,140                          43,111                          40,848        
---------------------------------------------------------------------------------------------------------------------------------
                                    
Total Liabilities & Stockholders' 
 Equity                             $578,090                        $580,860                        $642,487
                                    ========                        ========                        ========
Net Interest Income (a)                        $30,016                         $29,468                         $28,478
                                               =======                         =======                         =======
                                    
Yield Spread                                               4.83%                           4.89%                           4.44%
                                                          ======                          ======                          ======   
                                    
NET INTEREST INCOME TO
 EARNING ASSETS                                            5.55%                           5.53%                           4.95%
================================================================================================================================

<Fa>   Tax exempt interest has been converted to a tax equivalent basis 
       using the Federal tax rate of 34%.
<Fb>   Includes nonaccruing loans.
</TABLE>

The following table sets forth, for each major category of interest earning 
assets and interest bearing liabilities, the dollar amounts of fully taxable 
equivalent interest income and interest expense and changes therein for 1997 
as compared with 1996.

                         Merchants Bancshares, Inc.
                 Analysis of Changes in Net Interest Income

<TABLE>
<CAPTION>
                                               1997 vs 1996                                         1996 vs 1995
----------------------------------------------------------------------------------------------------------------------------------
                                                  Increase    --Due to (a) --                         Increase   --Due to (a) --
(In thousands)                   1997     1996   (Decrease)   Volume    Rate       1996      1995    (Decrease)  Volume     Rate
----------------------------------------------------------------------------------------------------------------------------------
<S>                            <C>      <C>       <C>         <C>     <C>        <C>       <C>        <C>        <C>       <C>
Interest Income:               $38,528  $40,089   ($1,561)     $  0   ($1,561)   $40,089   $46,232    ($6,143)   ($7,371)  $1,228
  Loans (b)                                        
Investment Income:                                        
  Taxable                        9,615    7,736     1,879       (30)    1,909      7,736     4,882      2,854      2,090      764
Federal Funds Sold                 111      315      (204)        0      (204)       315       366        (51)       (23)     (28)
----------------------------------------------------------------------------------------------------------------------------------
       Total                   $48,254  $48,140    $  114     ($ 30)   $  144    $48,140   $51,480    ($3,340)   ($5,304)  $1,964
----------------------------------------------------------------------------------------------------------------------------------
                                        
Less Interest Expense:                                        
  Savings, Money Market & 
   NOW Accounts                $ 8,452  $ 8,217    $  235      $  0    $  235    $ 8,217   $ 9,077    ($  860)   ($  474) ($  386)
  Time Deposits $100 thousand
   and Greater                     821    1,396      (575)       31      (606)     1,396     1,433        (37)       (60)      23
  Other Time                     8,043    8,112       (69)      (13)      (56)     8,112     8,981       (869)      (948)      79
  Federal Funds Purchased           54       32        22         0        22         32        58        (26)       (12)     (14)
  Demand Note--U.S. Treasury       130      108        22        12        10        108       173        (65)       (55)     (10)
  Debt and Other Borrowings        738      807       (69)      106      (175)       807     3,280     (2,473)    (1,600)    (873)
----------------------------------------------------------------------------------------------------------------------------------
                                        
       Total                   $18,238  $18,672   ($  434)     $136   ($  570)   $18,672   $23,002    ($4,330)   ($3,149) ($1,181)
----------------------------------------------------------------------------------------------------------------------------------
                                        
       Net Interest Income     $30,016  $29,468    $  548     ($167)   $  715    $29,468   $28,478     $  990    ($2,155)  $3,145
==================================================================================================================================

<Fa>   The dollar amount of changes in interest income and interest expense 
       attributable to changes in rate and volume has been allocated 
       between rate and volume based upon the changes in rates times the 
       first year's volume and the changes in volume times the current 
       year's rate.
<Fb>   Includes balances of non-accruing loans.

<FN>Note:  Included in Interest Income are fees on loans totaling $1,619 and 
           $2,333 for the years ended December 31, 1997 and 1996, respectively.
</TABLE>

LOAN PORTFOLIO

The following tables display the composition of the Bank's loan portfolio 
for the consecutive five year period 1993 through 1997, along with a 
schedule profiling the loan maturity distribution over the next five years.

COMPOSITION OF LOAN PORTFOLIO

The table below presents the composition of the Bank's loan portfolio by 
type of loan as of December 31 for each of the past five years. Amounts are 
shown gross of net deferred loan fees of $859 thousand in 1997, $947 
thousand in 1996, $956 thousand in 1995, $1,132 thousand in 1994 and $1,310 
in 1993, which principally relate to real estate mortgages.

<TABLE>
<CAPTION>
                                              As of December 31,
Type of Loan                  1997       1996        1995       1994       1993
---------------------------------------------------------------------------------
                                               (In thousands)
<S>                         <C>        <C>         <C>        <C>        <C>
Commercial, Financial &
 Agricultural               $ 73,523   $ 61,091    $ 76,925   $ 92,612   $105,631
Real Estate--Construction      8,695      3,420       9,644     21,992     30,526
Real Estate--Commercial      155,983    178,780     197,591    204,023    236,666
Real Estate--Residential     136,305    128,577     148,611    173,406    176,446
Installment                   15,450     14,831      16,560     18,086     22,836
Lease Financing                   --         --          --         --         42
All Other Loan                   432        534         393        436      1,324
---------------------------------------------------------------------------------
                            $390,388   $387,233    $449,724   $510,555   $573,471
=================================================================================
</TABLE>

PROFILE OF LOAN MATURITY DISTRIBUTION

The table below presents the distribution of the varying maturities or 
repricing opportunities of the loan portfolio at December 31, 1997. All 
dollar amounts are expressed in thousands.

<TABLE>
<CAPTION>
                                              Over One
                                  One Year     Through   Over Five    
Type of Loan                       Or Less     5 Years     Years       Total
-----------------------------------------------------------------------------
                                                  (In thousands)
<S>                               <C>         <C>         <C>        <C>
Commercial Loans, Industrial
 Revenue Bonds, Lease Financing
 and All Other Loans              $ 50,887    $ 12,269    $10,800    $ 73,956
Real Estate Loans                  138,761      89,012     73,209     300,982
Installment Loans                    3,595       4,983      6,872      15,450
-----------------------------------------------------------------------------
                                  $193,243    $106,264    $90,881    $390,388
=============================================================================
</TABLE>

Loans maturing or repricing after one year which have predetermined interest 
rates totaled $196.0 million. Loans maturing or repricing after one year 
which have floating or adjustable interest rates totaled $1.1 million.

In 1997, a total of 366 one-to-four family residential mortgage loans were 
closed by the bank, totaling $26.7 million. Substantially all of these 
originations were placed in the Bank's portfolio. The Bank currently 
services $193.3 million in residential mortgage loans for other investors 
such as federal government agencies (FNMA and FHLMC) and for financial 
investors such as insurance companies and pension funds located outside 
Vermont. 

During 1997, the Bank remained an active participant in the U.S. Small 
Business Administration guaranteed loan program. 28 new SBA loans totaling 
$3.4 million were originated during 1997 with SBA guarantees ranging from 
70% to 85%. This volume of new lending activity represents a decrease of 21% 
from that experienced in 1996.

Substantially all of the SBA and residential mortgage loans originated in 
1997 have remained in portfolio. SBA guarantees are advantageous to the Bank 
because they reduce risk in the Bank's loan portfolio and allow the Bank to 
increase its commercial loan base and market share with minimal impact on 
capital. The Bank's ALCO made the decision a year ago to hold most of its 
originated loans in portfolio instead of selling them on the secondary 
market. This strategic decision will help the Bank in its efforts to 
diversify the loan portfolio, with greater emphasis on small business, 
commercial and residential home mortgage lending and less on commercial real 
estate. 

During 1997, the Bank originated 520 commercial loans, totaling $74.4 
million. This lending activity represented an increase of approximately 13% 
of new loan volume from that experienced in 1996. Commercial loans were 
originated throughout Vermont.

LOAN PORTFOLIO MONITORING

The Bank's Board of Directors grants each loan officer the authority to 
originate loans on behalf of the Bank. The Board also establishes 
restrictions regarding the types of loans that may be granted and the 
distribution of loan types within the portfolio, and sets loan authority 
limits for each lender. These authorized lending limits are established at 
least annually and are based upon the lender's knowledge and experience. 
Loan requests that exceed a lender's authority are referred to the Credit 
Department. All extensions of credit of $2.5 million to any one borrower, or 
related party interest, are reviewed and approved by the Directors Loan 
Committee.

By using a variety of management reports, the Bank's loan portfolio is 
continuously monitored by the Board of Directors and Credit Department. The 
loan portfolio as a whole, as well as individual loans, are reviewed for 
loan performance, creditworthiness, and strength of documentation. The Bank 
has hired an external loan review firm to assist in portfolio monitoring. 
Credit risk ratings are assigned to commercial loans and are routinely 
reviewed.

All loan officers are required to service their own loan portfolios and 
account relationships. As necessary, loan officers or the loan workout 
function takes remedial actions to assure full and timely payment of loan 
balances.

LOAN QUALITY AND RESERVES FOR POSSIBLE LOAN LOSSES

Merchants Bank reviews the adequacy of the Reserve for Possible Loan Losses 
("RPLL") at least quarterly. The method used in determining the amount of 
the RPLL is not based on maintaining a specific percentage of RPLL to total 
loans or total nonperforming assets, but rather a comprehensive analytical 
process of assessing the credit risk inherent in the loan portfolio. This 
assessment incorporates a broad range of factors, which indicate both 
general and specific credit risk, as well as a consistent methodology for 
quantifying probable credit losses. As part of the Bank's analysis of 
specific credit risk, a detailed and extensive review is done on larger 
credits and problematic credits identified on the watched asset list, 
nonperforming asset listings and credit rating reports. Loans deemed 
impaired at December 31, 1997 totaled $4.8 million. Impaired loans have been 
allocated $665 thousand of the RPLL.

On June 4, 1993, the Bank acquired New First National Bank of Vermont 
(NFNBV). The terms of the Purchase and Assumption Agreement (the 
"Agreement") required the FDIC to reimburse the Bank 80% of the net charge-
offs up to $41 million on any acquired loans that qualify as loss-sharing 
loans, for a period of three years from the date of acquisition. Losses in 
excess of $41 million would be reimbursed at 95%. The Agreement expired 
effective June 30, 1996, with respect to the reimbursement of losses. The 
Bank is required to return to the FDIC 80% of any reimbursed losses 
recovered, during the two year period following the expiration date.

As of June 30, 1996, the remaining balance of loss-sharing loans aggregated 
$48.2 million; included in that balance was $2.9 million in nonperforming 
loans. Due to the expiration of the loss-sharing agreement, management 
adjusted the analysis of the RPLL to account for 100% of the loss exposure 
associated with acquired loans that qualified as loss-sharing. The RPLL 
analysis prepared the quarter ended March 31, 1996 showed an increase in the 
reserve requirement of approximately $1.4 million, due to the expiration of 
the Agreement. Management maintained the RPLL at a level adequate to offset 
the required increase in the reserve requirement; therefore, no additional 
provision was necessary due to the expiration of the Agreement.

Overall, management believes that the RPLL is maintained at an adequate 
level, in light of historical, current and prospective factors, to reflect 
the level of risk in the loan portfolio. Loan loss experience and 
nonperforming asset data are presented and discussed in relation to their 
impact on the adequacy of the RPLL.

The table below reflects the Bank's loan loss experience and activity in the 
RPLL for the past five years.

       Loan Losses and Reserve for Possible Loan Losses Reconciliation
                              December 31, 1997

<TABLE>
<CAPTION>
(In thousands)                     1997        1996        1995        1994        1993
-----------------------------------------------------------------------------------------
<S>                              <C>         <C>         <C>         <C>         <C>
Average Loans Outstanding        $393,737    $406,514    $481,047    $514,843    $515,805
-----------------------------------------------------------------------------------------
RPLL Beginning of Year             15,700      16,234      19,929      20,060       7,412
Charge-Off :                    
  Commercial, Lease Financing
   and all Other Loans               (483)       (907)     (3,671)     (3,356)     (5,567)
  Real Estate--Construction           (78)       (602)     (1,485)     (1,159)       (275)
  Real Estate--Mortgage              (763)     (3,206)    (12,942)     (7,673)     (7,651)
  Installment & Credit Cards         (372)       (405)       (263)       (462)       (459)
-----------------------------------------------------------------------------------------
      Total Loans Charged Off      (1,696)     (5,120)    (18,361)    (12,650)    (13,952)
-----------------------------------------------------------------------------------------
Recoveries:                    
  Commercial, Lease Financing
   and all Other Loans                615         391       1,232       1,187         392
  Real Estate--Construction            --          63          32         400          --
  Real Estate--Mortgage             2,996         856       1,224         769         301
  Installment & Credit Cards           78         125          78         163          85
-----------------------------------------------------------------------------------------
      Total Recoveries              3,689       1,435       2,566       2,519         778
-----------------------------------------------------------------------------------------
Net Loan Losses                     1,993      (3,685)    (15,795)    (10,131)    (13,174)
-----------------------------------------------------------------------------------------
Provision for Loan Losses:                    
  Charged to Operations(1)         (1,862)      3,150      12,100      10,000      23,882
  Loan Loss Reserve (2)                                                             2,000
-----------------------------------------------------------------------------------------
RPLL End of Year                 $ 15,831    $ 15,700    $ 16,234    $ 19,929    $ 20,060
=========================================================================================
RPLL to Total Loans                 4.06%       4.05%       3.61%       3.90%       3.50%
Net Losses to Average Loans        -0.51%       0.91%       3.28%       1.97%       2.28%
-----------------------------------------------------------------------------------------

<F1>  The loan loss provision is charged to operating expense. When actual 
      losses differ from these estimates, and if adjustments are considered 
      necessary, they are reported in operations in the periods in which 
      they become known.
<F2>  See Note 3 to the consolidated financial statements regarding the 
      acquisition of New First National Bank of Vermont.
</TABLE>

The RPLL increased from $15.7 million at December 31, 1996 to $15.8 million 
at December 31, 1997.  Due to the continued strength of the Bank's asset 
quality, and management's assessment of the adequacy of the loan loss 
reserve as an indicator of that strength, the Bank discontinued providing 
for loan losses during the second quarter of 1997, after taking a $300 
thousand provision in the first quarter of the year. The total provision for 
loan losses in 1996 was $3.1 million. During the fourth quarter of 1997, the 
Bank recognized recoveries on two previously charged down loans of $2.2 
million. This amount was credited to income through the provision for loan 
losses. This discontinuation of loan loss provisions and the stable reserve 
balances reflect the improvement in asset quality. These improvements are 
further noted in the reduction of net loan losses and nonperforming assets, 
as noted in the following tables:

NONPERFORMING ASSETS

The following tables summarize the Bank's nonperforming assets (NPAs) as of 
December 31, 1993 through 1997.

<TABLE>
<CAPTION>
(In thousands)                        1997      1996      1995       1994       1993
--------------------------------------------------------------------------------------
<S>                                  <C>       <C>       <C>        <C>        <C>
Nonaccrual Loans                     $2,686    $4,091    $25,617    $32,200    $47,069
Loans Past Due 90 Days or
 More and Still Accruing                403       216        237        668        715
Restructured Loans                      215     2,403      1,430      5,083      2,841
--------------------------------------------------------------------------------------
      Total Nonperforming Loans:      3,304     6,710     27,284     37,951     50,625
--------------------------------------------------------------------------------------
Other Real Estate Owned                 591     1,925      7,772     13,231     13,674
--------------------------------------------------------------------------------------
      Total Nonperforming Assets:    $3,895    $8,635    $35,056    $51,182    $64,299
======================================================================================
NPL to Total Loans                    0.85%     1.70%      3.61%      3.90%      3.50%
NPA to Total Loans plus OREO          1.00%     2.20%      3.28%      1.97%      2.28%
--------------------------------------------------------------------------------------
</TABLE>

Excluded from the 1997 balances above are approximately $12.7 million of 
internally classified loans. These loans have well-defined weaknesses which, 
if left unattended, could lead to collection problems. Management maintains 
an internal listing, which includes these loans, which is reviewed and 
updated monthly. The oversight process on these loans includes an active 
risk management approach. A management committee reviews the status of these 
loans each quarter and determines or confirms the appropriate risk rating 
and accrual status. The findings of this review process are instrumental in 
determining the adequacy of the loan loss reserve.

DISCUSSION OF 1997 EVENTS AFFECTING NONPERFORMING ASSETS

Historically, the Company has worked closely with borrowers and also pursued 
vigorous collection efforts. The Company continued its efforts to collect 
troubled assets during 1997. The Company's enhanced Credit Department and 
Loan Workout functions provided resources to address collection strategies 
for nonperforming assets.

<TABLE>
<CAPTION>
(In thousands)               12-31-97    9-30-97    6-30-97    3-31-97    12-31-96
----------------------------------------------------------------------------------
<S>                           <C>        <C>        <C>        <C>         <C>
Nonaccrual Loans              $2,686     $3,175     $3,295     $3,316      $4,091
Loans Past Due 90 days or
 more and still Accruing         403        707        634         80         216
Restructured Loans               215      2,157      2,198      2,362       2,403
Other Real Estate Owned          591        225        330        516       1,925
---------------------------------------------------------------------------------
      Total                   $3,895     $6,264     $6,457     $6,274      $8,635
=================================================================================
</TABLE>

The more significant events affecting NPAs are discussed below.

Nonaccrual Loans

Nonaccrual loans declined from $4.1 million at December 31, 1996 to $2.7 
million at December 31, 1997. Management continued its efforts to 
proactively identify and resolve loans, which present significant risk of 
loss to the Bank. During 1997, management identified approximately $4.5 
million in accounts, which were transferred to nonaccrual status. These 
transfers were offset by continued resolution of nonaccrual accounts; 
approximately $1.0 million in loans were returned to accrual status; 
principal payments of approximately $1.5 million were collected; 
nonperforming loan sales were completed during the first and fourth quarters 
reducing nonaccruing loans by approximately $2.7 million. In addition, 
charges of approximately $800 thousand further decreased the balance of 
nonaccruing loans.

Loans Past Due 90 Days or More and Still Accruing Interest

The Bank generally places loans that become 90 or more days past due in 
nonaccrual status. If the ultimate collectibility of principal and interest 
is assured, loans may continue to accrue and be left in this category. 
Included in this category are loans which have reached maturity and have not 
been renewed on a timely basis, for reasons other than financial capacity to 
pay. Balances of loans past due 90 days have increased $187 thousand from 
year end 1996 to year end 1997. Approximately 70% of these balances carried 
a guaranty from the U.S. Small Business Administration.

Restructured Loans

Restructured loans (TDRs) decreased from $2.4 million at December 31, 1996 
to $215 thousand at December 31, 1997. A single transaction was the primary 
reason for the decrease. During the fourth quarter of 1997, a $2.0 million 
commercial real estate loan was paid off in conjunction with the sale of the 
underlying collateral. This loan was a restructured obligation, and 
contributed to the $2.2 million decrease in the restructured portfolio. 

Other Real Estate Owned and In-substance Forclosure

The Bank continued its success in 1997 in disposing of OREO and continues to 
aggressively market such properties. The balance of OREO, net of reserves, 
decreased from $1.9 million at December 31, 1996 to $591 thousand at 
December 31, 1997. Of the total balance $36 thousand represents foreclosed 
real estate. The balance of $555 thousand are bank owned properties that the 
Bank has made the strategic decision to sell. In cases where these 
properties house operating branches the Bank generally plans to sell the 
real estate and lease back the portion of the building used for branch 
purposes.

POLICIES AND PROCEDURES RELATING TO THE ACCRUAL OF INTEREST INCOME

The Bank normally recognizes income on earning assets on the accrual basis, 
which calls for the recognition of income as earned, as opposed to when it 
is collected. The Company's policy is to classify a loan more than 90 days 
past due with respect to principal or interest as a nonaccruing loan, unless 
the ultimate collectibility of principal and interest is assured. Income 
accruals are suspended on all nonaccruing loans, and all previously accrued 
and uncollected interest is typically charged against current income. A loan 
remains on nonaccruing status until the factors which suggest doubtful 
collectibility no longer exist, the loan is liquidated, or when the loan is 
determined to be uncollectible and is charged off against the reserve for 
possible loan losses. In those cases where a nonaccruing loan is secured by 
real estate, the Company can, and usually does, initiate foreclosure 
proceedings. The result of such action is to force repayment of the loan 
through the proceeds of a foreclosure sale or to allow the Company to take 
possession of the collateral in order to manage a future resale of the real 
estate. Foreclosed property is recorded at the lower of its cost or 
estimated fair value, less any estimated costs to sell. Any cost in excess 
of the estimated fair value on the transfer date is charged to the reserve 
for possible loan losses, while further declines in market values are 
recorded as an expense in other noninterest expense in the statement of 
operations. As of December 31, 1997 and 1996, the Company had valuation 
reserves against the other real estate owned portfolio carrying values of 
$653 thousand and $2.7 million, respectively.

ITEM 7--MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
        CONDITION AND RESULTS OF OPERATIONS

Please refer to pages 33-42 for Management's Discussion and Analysis of 
Financial Condition and Results of Operations.

ITEM 8--FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The consolidated balance sheets of Merchants Bancshares, Inc. as of December 
31, 1997 and 1996, and the related consolidated statements of operations, 
changes in stockholders' equity and cash flows for each of the three years 
in the period ended December 31, 1997, together with the related notes and 
the opinion of Arthur Andersen LLP, independent public accountants, all as 
contained on pages 2 through 30 of the Company's 1997 Annual Report to 
Shareholders on Form 10-K, are incorporated herein by reference.

ITEM 9--CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
        ON ACCOUNTING AND FINANCIAL DISCLOSURES

None.

                                  Part III

ITEM 10--DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

ITEM 11--EXECUTIVE COMPENSATION

ITEM 12--SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

ITEM 13--CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

Reference is hereby made to pages 3 through 5, pages 8 through 10, page 13, 
and page 15 of the Company's Proxy Statement to Shareholders dated March 6, 
1998, wherein pursuant to Regulation 14A information concerning the above 
subjects (Items 10 through 13) is incorporated by reference.

Pursuant to Rule 12b-23, definitive copies of the Proxy Statement will be 
filed within 120 days subsequent to the end of the Company's fiscal year 
covered by Form 10-K.

                                   PART IV

ITEM 14--EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(1)  The following consolidated financial statements, as included in the 
     1997 Annual Report to Shareholders, are incorporated herein by reference:

     Consolidated Balance Sheets, December 31, 1997 and December 31, 1996.

     Consolidated Statements of Operations for years ended December 31, 
     1997, 1996 and 1995.

     Consolidated Statements of Changes in Stockholders' Equity for years 
     ended December 31, 1997, 1996 and 1995.

     Consolidated Statements of Cash Flows for the years ended December 31, 
     1997, 1996 and 1995.

     Notes to Consolidated Financial Statements, December 31, 1997.

(2)  The following exhibits are either filed or attached as part of this 
     report, or are incorporated herein by reference.

Exhibit    Description

  3.1      Restated Certificate of Incorporation of the Company 
           (Incorporated by reference to Exhibit B to Pre-Effective Amendment
           No. 1 to Company's Definitive Proxy Statement for the Annual Meeting
           of the Stockholders of the Company, filed on April 25, 1987)

  3.2      Amended By-Laws of the Company (Incorporated by reference to 
           Exhibit C to Company's Definitive Proxy Statement for the Annual
           Meeting of the Stockholders of the Company, filed on April 25,
           1987).

  4        Instruments defining the rights of security holders, including 
           indentures:

  4.1      Specimen of the Company's Common Stock Certificate (Incorporated
           by Reference to Exhibit 7 to the Company's Registration Statement
           on Form S-14 (Registration Number 2-86108) filed on August 22, 1983)

  4.2      Description of the rights of holders of the Company's Common Stock
           (appearing on page 9 of the Company's Registration Statement on
           Form S-14 (Registration No. 2-86108) filed on August 22, 1983)

 10.1      Merchants Bancshares, Inc. Dividend Reinvestment and Stock Purchase
           Plan (Incorporated by reference to Exhibit 4.1 to Company's
           Registration Statement on Form S-3 (Registration No. 333-20375)
           filed on January 22, 1997)

 10.2      401(k) Employee Stock Ownership Plan of the Company, dated January
           1, 1990, as amended (Incorporated by reference to Company's
           Registration Statement on Form S-8 (Registration Number 33-3274)
           filed on November 16, 1989)

 10.3      Amended and Restated Merchants Bank Pension Plan dated as of January
           1, 1994 (Incorporated by Reference to Exhibit 10.6 to Post-Effective
           Amendment Number 1 to Company's Registration Statement on Form S-8 
           (Registration Number 333-18845) filed on December 26, 1996)

 10.5      Employment Agreement dated as of January 1, 1997, by and between the
           Company, Merchants Bank and Joseph L. Boutin (Incorporated by
           reference to the Registrant's Annual Report on Form 10-K for the
           Year Ended December 31, 1996)

 10.7      Employment Agreement dated as of January 1, 1997, by and between
           Merchants Bank and Michael R. Tuttle (Incorporated by reference to 
           the Registrant's Annual Report on Form 10-K for the Year Ended
           December 31, 1996)

 10.9      Employment Agreement dated as of January 1, 1997, by and between
           Merchants Bank and Thomas R. Havers (Incorporated by reference to
           the Registrant's Annual Report on Form 10-K for the Year Ended
           December 31, 1996)

 10.11     Employment Agreement dated as of January 1, 1997, by and between
           Merchants Bank and Thomas S. Leavitt. (Incorporated by reference to 
           the Registrant's Annual Report on Form 10-K for the Year Ended
           December 31, 1996)

 10.12     Employment Agreement, dated as of January 1, 1998 by and between
           Merchants Bank and Janet P. Spitler.

 10.13     Employment Agreement, dated as of January 1, 1997, by and between
           Merchants Bank and Merchants Trust Company and William R. Heaslip 
           (Incorporated by reference to the Registrant's Annual Report on Form
           10-K for the Year Ended December 31, 1996).

 10.14     The Merchants Bank Amended and Restated Deferred Compensation Plan
           for Directors (Incorporated by reference to the Registrant's 
           Annual Report on Form 10-K for the Year Ended December 31, 1996).

           10.14.1    Trust Under the Merchants Bank Amended and Restated
                      Deferred Compensation Plan for Directors (Incorporated
                      by reference to the Registrant's Annual Report on Form
                      10-K for the Year Ended December 31, 1996).

 10.15     Agreement among the Merchants Bank and Kathryn T. Boardman, Thomas
           R. Havers and Susan D. Struble dated as of December 20, 1995
           (Incorporated by reference to the Registrant's Annual Report on
           Form 10-K for the Year Ended December 31, 1996).

           10.15.1    Trust Under the Agreement among the Merchants Bank and
                      Kathryn T. Boardman, Thomas R. Havers and Susan D.
                      Struble dated as of December 20, 1995 (Incorporated by
                      reference to the Registrant's Annual Report on Form 10-K
                      for the Year Ended December 31, 1996).

 10.16     Agreement between the Merchants Bank and Dudley H. Davis dated
           December 20, 1995 (Incorporated by reference to the Registrant's 
           Annual Report on Form 10-K for the Year Ended December 31, 1996).

           10.16.1    Fixed Trust under Agreement between the Merchants Bank
                      and Dudley H. Davis dated December 20, 1995 (Incorporated
                      by reference to the Registrant's Annual Report on Form
                      10-K for the Year Ended December 31, 1996).

           10.16.2    Variable Trust under Agreement between the Merchants
                      Bank and Dudley H. Davis dated December 21, 1995
                      (Incorporated by reference to the Registrant's Annual
                      Report on Form 10-K for the Year Ended December 31,
                      1996).

 11        Statement re: computation of per share earnings. See 1997 Annual 
           Report to Shareholders, Note 11.

 13        1997 Annual Report to Shareholders

 21        Subsidiaries of the Company

 23        Consent of Arthur Andersen LLP

 27        Financial Data Schedule

 (3)       Reports on Form 8-K: NONE


                                 SIGNATURES

Pursuant to the requirement of Section 13 or 15(d) of the Securities 
Exchange Act of 1934, the registrant has duly caused this report to be 
signed on it's behalf by the undersigned, thereunto duly authorized.

Merchants Bancshares, Inc.

Date  February 20, 1998                By /s/ Joseph L. Boutin
     -------------------------            ---------------------------------
                                          Joseph L. Boutin, President & CEO

Pursuant to the requirement of the Securities Exchange Act of 1934, this 
report has been signed below by the following persons on behalf of MERCHANTS 
BANCSHARES, INC., and in the capacities and on the date as indicated.

By /s/ Joseph L. Boutin                  By /s/ Raymond C. Pecor, Jr.
   -------------------------------------    ----------------------------------
   Joseph L. Boutin, Director, President    Raymond C. Pecor, Jr. Director
   & CEO of the Company and the Bank        Chairman of the Board of Directors


By                                       By
   -------------------------------------    ----------------------------------
   Peter A. Bouyea, Director                Charles A. Davis, Director


By /s/ Robert A. Skiff                   By /s/ Jeffrey L. Davis
   -------------------------------------    ----------------------------------
   Robert A. Skiff, Director                Jeffrey L. Davis, Director


By /s/ Michael G. Furlong                By
   -------------------------------------    ----------------------------------
   Michael G. Furlong, Director             Benjamin F. Schweyer, Director


By /s/ Janet P. Spitler                  By /s/ Leo O'Brien, Jr.
   -------------------------------------    ----------------------------------
   Janet P. Spitler, Treasurer of the       Leo O'Brien, Jr, Director
   Company, Vice President, CFO,
   and Treasurer of the Bank


By /s/ Patrick S. Robins
   -------------------------------------
   Patrick S. Robins, Director